It’s your biggest bill — is there any reason to keep it?
If you’re reading this from the U.S. or Canada and own a home, chances are you have a mortgage. And if you have a mortgage, you’ve no doubt wondered from time-to-time if it is possible to pay it off early. As I previously showed in How to get rid of your mortgage, it is.
But today I’d like to discuss whether you SHOULD pay off your mortgage.
There are two distinct camps in this discussion.
One one side, there’s the “peace of mind” camp. These guys advocate for getting rid of this debt as soon as possible to remove stress from their family. These folks tend to be naturally opposed to debt in the first place and taking on a mortgage in the first place was only an act of necessity. You can read more about this point of view here.
In the other camp are the investors. The investors can’t bear to have even a single dollar making less than its maximum potential. These guys look at today’s low interest rates, realize they can do better in the market and feel they are losing money by putting their money where the interest rate is so low. You can read a good writeup on this perspective here.
And, like any good disagreement, there are those that fall in-between, which is where I land, although I definitely lean toward the “peace of mind” peeps.
But let’s take a deeper look.
The investors often mention a 5% yield on investments as being a reasonable goal in today’s market. You might want to shoot for more if you’re particularly aggressive or young but you might want to aim for 3-4% if you’re older and/or need to be more conservative. But for purposes of discussion, we’ll use 5% as a good target.
So if you can earn 5%, does it make sense to target your funds at a rate of less than 4%? As of this morning, you can get a loan (theoretically) for 3.5%. Nice, right? An extra margin of 1.5% going to YOU!
Let’s pause, though, to recall what an interest rate represents. If you remember your basic economics, an interest rate is just the market representation of risk. If you’re a less risky borrower, you’ll get a cheaper rate when you buy your house. Same on the investing side, you can find investments that earn 10% or more, but your money is increasingly at risk the higher up you go.
So when thought of in that way, we should look at paying off our mortgage as “earning” the rate of our home’s interest rate. Or, in other words, we can earn a relatively safe 3.5%. I also like thinking of the principal of your home as “savings” and the interest you pay as the “cost”.
Good reasons to consider NOT paying off a mortgage
- Your employment is secure for the long-term
It’s easy to forget how massive the bloodbath of 2008 was. Many (many!) people who never even considered they’d be out of work were suddenly faced with bills they couldn’t pay. But if you believe you’re completely safe from job risk or have other “safe” income sources, you could stay leveraged. - You have adequate safety measures in place
Because no one knows what will happen, you have to be ready for anything. A year of your monthly expenses kept in relatively safe, accessible investments should be adequate to keep you out of trouble. - You are relatively young
I’m not a fan of people in their 40s and 50s staying highly leveraged just to squeeze a bit more out of their investments. For younger people, they are in a better position to withstand a downturn. - Family situation
If you have kids, you might be more focused on increasing your security more than in building up your investment fund. - You have a high risk tolerance
Being willing to lose large sums of money comes with the territory if you’re choosing investing over removing debt. - You are highly disciplined
Most people who say they’re staying leveraged for investment reasons inadvertently end up loosening up their cashflow and spending rises, leaking their funds out to the consumerist world. - Inflation
Should we run into a hyperinflationary period as many believe we will, your “locked-in” payment amount will be trivial compared to your newly “inflated” income.
Good reasons to consider paying off a mortgage
- You’re in your 40s or 50s
If you’re working toward pretirement and can see traditional retirement looming on the horizon already, you should be grateful we’re in a low interest rate environment. In times past you’d be stuck swallowing massive amounts of interest as you worked to tame your mortgage. (It’d be even more important to do so in a higher interest world, however.) With low interest rates, though, you can much more rapidly work this debt down and thus lower your needed investment number to reach pretirement. - You can’t stand having debt
We often overlook emotional needs when talking finances. But we’re living our lives here. If it stresses you out to carry debt, by all means get rid of it! - You couldn’t handle large investment losses
Beyond emotional reasons, a massive investment loss could devastate some people. You can build a safety wall against big losses by removing debt instead of playing the market. - Your balance is small
If you have a relatively small amount left to pay on your mortgage, it might be worth getting rid of that annoyance as soon as possible. - Your job is shaky
If you think your job could be at risk, living mortgage-free will greatly increase your safety margin. - A paid-off mortgage can act as a safety fund
When a mortgage is paid off, it’s trivial to get a line of credit for emergencies. Hopefully you’ll never need it, but it’s great to have a large fund available. This allows you to keep the rest of your money invested as aggressively as possible.
Now I don’t advocate paying small additional amounts to principle over the years. This strategy is actually designed for people that don’t know how to manage their money, locking it away from them so they don’t piss it away. I recommend saving and investing outside of your mortgage for eventual pay-off or refinance. That means keeping this money semi-liquid and trying to earn more with that money over the years.
One could also consider a hybrid strategy: Pay off the majority of your loan and invest a smaller, controlled amount, say, $50,000 or $100,000. It lowers your risk but also lets you gain additional earning from a decent chunk of money. That may be just enough peace of mind to make it worth your while.
When we talk pretirement, however, the goal is to bring financial freedom within reach as quickly as possible. This is why I lean toward the Pay Off camp. By lowering your overhead, you have a clear target for monthly income and can even rely on part-time work to cover those bills. It’s typically one’s mortgage that keeps one working full-time. Look at your own bills and let me know in the comments if that is not true for you.
