When it Makes Sense to Pay-off Your Mortgage Early

Payoff mortgage earlyPart of the journey here at the headquarters of AbandonedCubicle.com is removing obstacles to a life of freedom and choices. If you own a house, or have owned one in the past, you know all about the stress of having a mortgage (or two) hanging over your head.

Let’s dig into that notion of “removing obstacles” and see if we can agree that paying down the mortgage early makes good sense, or not.

If you do your research, you’ll find a lot of conflicting advice about the financial wisdom of paying off a mortgage early. Some of the best, most well-researched articles are themselves conflicted. You don’t come away with a clear-cut answer. That’s what makes early mortgage payment a tortuous decision for those of us on the Financial Independence, Retire Early (FIRE) journey.

He's leaning towards paying of the mortgage
He’s leaning towards paying of the mortgage

My Thought Process

When considering the idea of mortgage pay down, the first bit of advice you’ll want to heed is to make sure any high interest loans are paid off first. If you’re carrying any student loans, car loans, or credit card debts, chances are those interest rates are higher than your mortgage.

I’m bending that rule a bit personally. We have a large chunk of student loans still unpaid from Mrs. Cubert’s post-graduate studies.

Since the loan rate is only 2% (roughly the rate of inflation) it doesn’t make much sense to pay down the loan any faster. Payments are about a quarter of what we each month on the mortgage, so from an ongoing expense perspective, it’s something we can easily tackle after the corporate life is behind us.

Many well-informed folks would argue that even after you’ve paid off all your higher interest loans and obligations, it still doesn’t make good financial sense pay down the mortgage early.

The reason is opportunity cost

In theory, you could be putting all that good money into the stock market and realizing a yield of up to 9%, or into real estate, where returns could eclipse 20%. So why not just hang onto the mortgage? Skim off the margin between your mortgage rate of say 4%, and a theoretical stock market yield of 9%, gaining you a 5% return?

(and that’s not including the tax deduction on the mortgage interest!)

This is the nut to crack for me. You need to consider that your wise accountant will capture your mortgage interest deduction in your returns. If you pay down and pay off your mortgage, you’ll lose this deduction. Further, if you’ve got a mindset that there’s always another opportunity to squeeze more juice out of the orange, you’ll struggle to step away from a 5% margin opportunity.

Here’s the thing. You never know what kind of swing is around the corner with the stock market. There very well could be a slump like the ones that occurred in the early 90s or the late 00’s. You just can’t rely on a 9% return if your window is a decade or less.

The market is a fine venture for the long haul, like, say, 20 to 30 years or more. But at 10 years or less, you’re sort of gambling.

A pro of NOT paying off your mortgage early: You could spend a good chunk of time whittling away at the principal, but at any point in time, regardless how much principal is left, the bank can legally foreclose on you for a variety of reasons.

In a disaster situation where you’re left without a job and can no longer make payments, all that effort to pay down the mortgage is wasted in a nightmare foreclosure scenario. The bank owns your home until every last penny is paid.

So after that fun thought, why am I so hell-bent on paying off our house?

The main reason is this: It’s one less cloud hanging over my head. Can you put a price on that?

There are more objective reasons. Paying off the mortgage is like a hedge against the stock market. You’re getting a guaranteed 4% (or whatever your mortgage rate is) return with each payment. In the long term you’re saving tens and even hundreds of thousands in mortgage interest is a rewarding feeling.

Practically, part of the plan for my cubicle escape is to reduce or eliminate unnecessary monthly payments from the budget. Losing the mortgage means we’ll have $800 more each month in the kitty.

Some might argue, “Why have a mortgage at all?

Why not simply rent and avoid all the hassle?” I really respect this view and understand why many in the early retirement community lean towards renting over owning. For me, I simply enjoy customizing and perfecting our house.

I love that I can make modifications and answer to no one (except Mrs. Cubert, of course!) We don’t have to worry about the rent going up. We don’t have to worry about having to move if the landlord chooses to sell. I would subscribe to the approach Mr. Money Mustache has put out there: Rent in places where home prices are obscenely high, otherwise consider owning.

So, friends, what do you think? Are you on a path to pay off your mortgage early? Or do you have a different path that involves keeping your mortgage while investing elsewhere? Comment below!

Comments 4

  1. Asset diversification will keep me from going full tilt down the Mortgage Payoff route. The house you live in is often the biggest, most ill-liquid (even with a HELOC), and (from a historical perspective), the least well performing (Historical returns for personal housing have been either at or fractionally above inflation) of any of the assets that you hold. Right now the equity in my house represents 23% of my net worth, ideally I would like that number to be around 20% (which is a personal preference, that’s the thing about this hot topic, it all comes down to personal risk preference). I will toss the occasional fraction of a windfall (unusual paychecks, gifts from parents, etc) in it’s direction but my primary focus in not aimed at eliminating it. And even with that attitude, there is a sense of satisfaction each month watching that principle amount chunk down another 1k or so.

    Caveat, as the fraction of the interest goes down I will probably re-evaluate, since it may finally drift from being “good” debt. Also any changes in the tax code could change my opinion of it as well.

    1. All very sound points, Daniel. Really appreciate your bringing these comments to the post. As my friend whom got me into rentals suggests, paying down the mortgage is more an emotional decision. The numbers sometimes don’t convince.

  2. I’m doing a hybrid between the two. I round up the mortgage payment, and invest in a brokerage. Once the brokerage is equal to the remaining mortgage I can pay it off (if I desire at that time).

    If something happens, like an income loss, along the way I can withdraw from the brokerage to pay the mortgage.

    1. I like that strategy Mr. Doubling. For a while I considered socking away all our extra income into taxable accounts, then pull it to pay the mortgage in full when the 5-1 ARM expired.

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