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January 10, 2008

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Downright inspirational, thanks for sharing!

I'm sold. I'm following your lead the minute I wipe out my credit card debt... Right now, we're on pace to pay the mortgage off in 6 years (or 19 years early), but now I'm wanting to pick up the pace...

Well, I'm still too 'poor' to afford my own home, but I am applying the 'pay it off quick' methods to my car note. My credit union permits me to split the payment into two bi-weekly payments, which gains me one month every year. I also got the extended warranty refunded, knocking off eight additional months off the note.

If you don't mind me asking, what was your purchase price to family income ratio when you purchased the first home?

Did you make a descent amount of money on the sale? When you moved the second time, did you upgrade your housing, or find a very similarly priced home to the original in Michigan?

Awesome post. I think a lot of people make the mistake and buy a house well above their head. If they stick with this type of plan, the future will defintely look bright.

Awesome job and keep up the great work :)

That's our plan too... not sure if the wife is on board with not getting Everything we want in the next house though..... Oh well, we'll just have to pay that one off in 8 years too, I hope.

Great post. You give me more confidence in our plan!

Wow. That sounds great. We've been able to knock down our mortgage pretty substantially but you're an inspiration.

I would also be interested in finding out more about your sales and transitions. In particular, did you have major changes in your cost of living? If it went down (which I assume it did, since you advocate such a move), did you spend all of the money on a nice big home in the lower cost area, or did you buy a similar home and sock away the difference?

I paid off my house last August and it definitely was a liberating experience. I am 36 years old and bought a house 2 times my annual income. It took about 18 months of saving and planning to engineer this but it definitely is worth it if you plan on staying long term in one place. I have been dollar cost averaging my former mortgage payments into a 529 plan and additional investments. I think over the long run you will make out better mortgage-free. It all came down to buying a house we could easily afford and living within our means. Thanks for the post FMF!

Have you ever calculated the amount of money you would have if you put those dollars into an index fund instead of paying down your mortgage? An index fund would have returned 10% on an increasing balance, versus saving 6% on a decreasing balance. WEALTH is rarely created with DEBT. DEBT is not the enemy if WEALTH is the goal. Irresponsible debt is the enemy: credit cards, payday loans - stay away! A mortgage, student loans? Keep them as long as you can! I have about $100K in student loans between my wife and me. We are paying them off over 30 years and putting away tons of money.

Two ways to do it: Pay extra or save extra. $150K loan at 6% for 30 years. $900 payment.

Pay extra: Double your payment, pay off your home in 110 months (9 years, 2 months). Save $118,500 in interest.

Save extra: Pay an extra $900 into an index fund returning 8%. Pay off your home in 30 years. Pay an extra $118,500 in interest, and then save $30K in taxes. When your neighbor who paid extra on his house is "debt-free" (and Cash-Free!) in 9 years, You have $142K in the bank. And you only owe $129K on your house!

Which of these options is better?

You decide - I know what I'm doing.

The things you think you know about money are wrong.

Pardon my typo: WEALTH is rarely created WITHOUT debt!

We all know the math suggests NOT prepaying the mortgage and investing instead.

But, I'm still waiting for the day when I hear someone say "I wish I still had a mortgage payment each month." Plus, FMF continued to fully fund his 401k while prepaying the mortgage.

It's a personal decision to prepay or not; and both strategies make sense. I'm with FMF on this one.

Triciatim/Compounding --

I feel another post coming up -- giving a few of the details you asked for. I'll try to work it in the next month or so, but if you look at what aaktx said to get a glimpse of my dealings as well.

John K. --

Mike S. beat me to it and said what I was going to. For more details on my thoughts about paying off debt versus investing, see this link:

http://www.freemoneyfinance.com/2007/11/paying-off-a-mo.html

See, I think I want to challenge that conventional pfblog wisdom of investing in index funds rather than paying off the mortgage. (I know, this probably isn't the place to do it.)

Mortgages are paid with post-tax dollars, while index fund gains are taxed capital gains. So if you have a 7% mortgage, that's a 7% guaranteed post-tax loss on your money over 30 years. That's a really solid return on your assets. The "8%" that everyone always clamors about is a historical average; you have no idea what the market's going to be like over the long run, though conventional wisdom suggests an index fund will do well. Still, there's very little out there that will give you post-tax 7% guaranteed. The other benefit, of course, is the de-leveraging effect of paying off the mortgage. In a catastrophe you're not forced into a fire-sale of your assets (say a recession when you've lost your job) to pay the mortgage.

I think FMF's story's a great one. There's a reason so many people feel good when they've paid off their home. It really stabilizes your life.

Finance Monk, mortgage interest is tax deductible provided that you itemize as most people who own property can. So, yes 7% in mortgage is equivalent to 7% in gains that are taxed as regular income, and less than 7% in long-term capital gains and qualified dividends (or Roth IRA gains). I do agree that tax market returns aren't guaranteed; main reason I choose to pay off my mortgage. But.. If my mortgage interest had been 5% and not 7%, I'd probably kept the mortgage and invested the money.

It is nice not to have mortgage, though. Not only I can now save over half of my take-home (and that after max 401K contribution), but this difference between my expenses and income is sufficiently high that I can pay for most minor "emergencies" from the paycheck, not having to even touch the savings. How I did it - combination of buying a property that I could easily afford and good timing. I "upgraded" in mid-90s when the market was depressed and rented out previous residence that I sold in early 2000s with a nice gain. A couple of years too early, but it is difficult to predict the top. Curiously, I could've paid my mortgage sooner if I hadn't resisted selling about half of my stock at the top of internet boom. A friend suggested it, but I got greedy. This is one problem I always have with stocks - not knowing when to sell.

So here's another scenario to illustrate a point. Assume you have cash in the bank to buy a $150K home, you also have a job, steady income, and can make a mortgage payment of $900/mo for a $150K mortgage, 30 years, 6% interest. The "pay off the debt" crowd would say: "Use the cash to buy the house". This is taking the early payments argument to the extreme, you and I both realize, but the outcome is essentially the same, only to a larger degree.

I'm going to put my $150K into a CD at 5 percent. I will pay $900/mo for P&I on my mortgage. I will AVERAGE a tax savings of $1740/yr which I will add to my nest egg (this will actually be higher earlier, making it more beneficial than I will illustrate.) In 30 Years, my nest egg has grown to $788,100. I will then own my house, which I paid $150K in principal and about $174K in interest, for a total of about $324K. As a result of deducting interest paid, I save an extra $52K in taxes, $1740/yr on average in a 30 percent tax bracket.

Assets: House $150K (no appreciation) Savings: $788,100

Net Worth: $938,100

You are going to pay cash, and then accumulate savings at $900/mo at the same 5 percent rate. Your savings in 30 years will be worth $749,000.

Assets: House $150K (no appreciation) Savings: $749,000

Net Worth: $899,000

You might say, the difference is only about $40K, and I'd rather have the security of knowing I own my home, but remember that I also have the security of knowing I can pay it off - WHENEVER I WANT! I choose not to, because I know that debt is increasing my overall wealth.

Your house is a terrible place for your money - whether you put it into your mortgage payment or your mattress. Your house will appreciate in value no matter how much you owe on your mortgage. Keep your money in safe investments, invest for the long haul, and pay your mortgage off slowly. If you aren't concerned about that $40,000, I'll tell you where you can send me a check.

Not accepting economic realities does not make them false.

Perpetuating lies about money is irresponsible.

Learn how money works and it will work for you.

Look for your own answers, don't accept your parents' beliefs or FMF's.

Do whatever you want with your money, but do it with full awareness of what you are doing. If you want to be wealthy, debt is your friend.

I posted earlier in this discussion and came back to see additional comments. Personally I don't view my house as a beat-the-market-type investment. I know it is a slowly appreciating asset which will underperform the stock market over very long periods of time and maybe keep up with inflation. I looked at paying off my mortgage(I did it in about 18 months) as a conservative investment yielding me a guaranteed 6% yield. You could almost view it as the bond component of my portfolio. Using your money to invest rather then pay of your mortgage is a form of arbitrage(borrowing money at a low rate and earning a higher rate elsewhere). If your appetite for risk is decent, go for it. My appetite for risk is much better now that I know the roof over my head is paid for at the age of 36.

aaktx - Are you telling me that if you had unlimited access to money at 6% that you could earn 8% on somewhere else, you wouldn't take advantage of it? If you could borrow $1m at 6% and lend it at 8%, you'd make $20K. $10M - $200K. What about this doesn't make sense? Email me if you would like some reading materials that may be enlightening.

I bought my first residence (a condo outside the US where I live & work) cash. This was extremely fortuitous because in 2005 the US dollar was about 30% stronger than it is now so I basically used my spending power when it was stronger. Enough about this though.

The main thing FMF brings up is the size of the home they chose. This is critical, I think it's important to value the 'daily rent' of the place you buy or stay. Example, my place could rent in fair market value for about $1600 per month or a little more than $50 per night. This is the fair value of the place where I stay. If you have a house that can rent for $3000 per month then you are effectively consuming the value $100 every night you are staying there, plus utilities and incidentals. Consider the McMansions in California selling at $1.5 million per year. This mortgage on a 30 year fixed is $12,000 per month meaning the daily rent is $400! That can buy you a lot if you were to spend that on a 5 star hotel. Even more distressing is that $12,000 place can only be rented out for $5000 per month making owning a big losing proposition. So when you select a place to live keep this in mind. It will be key to your financial security.

Paying off the house instead of investing may look like you are losing money but you have to challenge all the assumptions (10% gain year on year in the stock market for example). A string of several bad years could make this strategy very costly.

-Big Cheese

-Big Cheese

Big Cheese-

You are missing the point. My example above uses a 5% interest rate, not 10 or 15%, which is possible but certainly not guaranteed. I do make some assumptions, but I think most people will agree they are fair ones.

You don't have to justify your decisions to me. I have no problem with someone paying cash for a house, just don't pretend like it was a smart financial decision.

The "rental value" of a home is only important if you are going to rent it out, and is certainly not the key to financial security.

John,

I appreciate your reply.

When I re-read your example above of investing $150K in a CD at 5% that would produce an annual return of $7500 or $625 per month. You will also have to pay income tax on this which will amount to $2250 per year at 30% tax bracket. For deducting mortgage interest this may be washed out by AMT or your earnings level. I would rather pay off a 6% mortgage note than keep it and invest in a 5% paying CD. In your calculations are you factoring the tax you'd have to pay each year on the interest from the CD?

-BC

Big Cheese,

My apologies for not calculating the taxes on the CD. I will do that and repost the data... I'm guessing that will push the dollar amount in favor of the mortgage.

However, the reason I didn't even think to do that is because I use tax-deferred/exempt vehicles (that have returned well over 5% historically). I use a vehicle that not only allows this to be tax-deferred/tax-exempt, but also allows me ready access to my capital, while sheltering it from the IRS, creditors, ex-wives, etc. This idea has been around for years, but has gotten very little publicity for reasons I can't explain.

Feel free to ask questions. I have nothing to sell, just information to share. This is by far the best way that I have seen to grow wealth. I think everyone needs to know about it.

If what you think you know about money is false... When do you want to find out the truth?

John K. --

You're arguing something that's not being debated (at least on this post.) Doesn't the first part of the post talk about the fact that I'm not covering which is better -- paying off a mortgage or not and investing? Are you actually reading what I said, or are you just arguing your point of view regardless?

FMF-

Great response for a Sunday!

I think anyone making a case for paying off a mortgage early should expect criticism if his/her stated goal is to "Grow Your Net Worth".

Your tagline and your story create dissonance with me and should with your readers. First you say "grow your net worth", then you say "pay off your mortgage early". I guess "grow your net worth" is just a cute saying, since your blog (this post anyway) is really about squandering your future wealth by paying down debt today.

I'm sorry if I didn't ask your permission to expand the discussion on YOUR blog. I thought that maybe this website was a place for the free expression and sharing of ideas about money, but clearly this is just a place for you to tell people about your money mistakes and package them as sound financial planning.

I will make sure that I email you and ask for your permission before I respond to anything else on this site, that is AFTER I respond to your response to my post on "Buy Term and Invest the Difference" on this page:

http://www.freemoneyfinance.com/2007/01/what_do_you_thi.html

The Truth will set you free!

Dear John K.

You clearly are impassioned about your views and disagree with paying down lower interest debt early. I paid my house off early and feel much more secure. I don't think my net worth will be more because of it, and you are correct that making 8% while paying 6% is profitable. I still don't believe my economic future is damned by retiring my mortgage early since I am saving a whole lot now. FMF advice is worth what you paid for it and I think that is a good thing.

aaktx-

I understand "feeling" secure, but good financial planning isn't based on feelings.

You future certainly isn't damned, but money is worth more today than tomorrow. The more you can put away early, the better off you will be. Everyone knows this.

If you will allow me to confess my "mea culpas" I will openly admit I didn't understand money very well until very recently. I bought too much house the first time, got a 15 year mortgage, I made extra payments, the works, but now I'm reformed and want to make sure others don't repeat my mistakes.

Money is an interesting thing and not well understood. Take this example: You have $150K in the bank to buy the $150K house, or you can invest that and make payments. This is very counterintuitive, but you can actually save more money with an 8% mortgage and a 6% rate of return on your $150K investment, because your savings are compounding on an INCREASING amount, while your mortgage compounds on a DECREASING amount.

Without taking taxes into consideration (it's late!) the total you will pay for the $150K house at 8% for 30 years is about $400K, while if you put $150K into savings at 6%, in 30 years it will be worth about $900K. (Taxes are left out - sorry sticklers)

I couldn't believe this when I saw it! But you can believe it got me looking at the way money works in a new light.

Hope that's helpful or at least insightful... If you can't use the information, you might pass it along to someone who can!

To your wealth,

John K.

John K. --

I understand you're new here, so let me spell out a few things for you:

1. This site is about growing your net worth. Since my net worth puts me in the top few % of all net worths in America, I think I have some points people may want to listen to.

2. This is a forum for free debate.

3. That said, it's also a forum where we respect other people and treat them as we'd like to be treated. I do not allow anyone to disparage another person, use threatening/demeaning language, and the like. If you keep doing this, you will not be allowed to continue on here.

John K--

You completely forgot to look at the flip side of your $150K...6% savings vs. 8% mortgage arguement.

If I pay for my $150K house with cash and instead pour my $1,111 monthly payment into 6% savings, then I will end up with $1,116,000. After 30 years, I'd be way ahead of your paltry $900K. Of course, using your logic, I left out the tax effect.

I guess I'd rather use my approach...pay for the $150K house up front, have peace of mind...pay my monthly payment to savings...and still end up with $200K more than your approach.

You really need to be more careful when dispensing your advice.

people always talk about the interest being tax deductible -- but with our 6.5% loan, the standard deduction is larger than what we get by itemizing, so that isn't an issue for us -- really only for people with huge loans (or lots of other deductions that we don't have.)

I think even if you pay off your home it will still go up in value.Dont forget if you upgrade your home before or after you pay off your home, you still getting equity in your home. Also you have to think about you still have to pay for taxes, water bill, electricity, and gas if you still living there.But you dont have to worry about the mortgage,which is the biggest payment.I know paying it slowly you get tax breaks,but i think paying off your mortgage and then sell your home, you will get 100% money that you sold it for and then buy another and invest in the rest.Thats what i think about it.

Reading this article and some of the counter arguments was time well spent. From both sides, back-of-the-envelop-calculation is being used to support both viewpoints. In reality, these do not work. There is a dynamic effect of market forces that needs to be taken into account. If the investment value reduces by 5% in a given year, it requires 10% increase just to catch up (not even considering value increase). Additionally, what about the impact of variable inflation in different sectors ? Real estate inflation vs. Change in value of money ? What about changes in quality-of-living ? etc.... These back-of-the-envelope calculation are good first step to dig further ?

We paid off a 30 year fixed (5.8%) in four years.
The tax deduction was a joke. Why pay 10k a year to a bank for 3k a year tax deduction?

I have a deal for you - if tax deductions are your bag. Send me 10k a year and every April, I'll send you 3k back. Most people, but not all, will reject that offer.

There is a quantifiable statistic called "risk" that lenders and their borrowers never discuss. Let me give you an example of "risk" for a mortgage. A 45 year old man has elected to make mortgage payments instead of paying a property off. He dies. His widow and heirs are faced with paying a property off, or continuing to make payments with lower family income.
Most folks counter this argument with Life Insurance premiums they pay while in debt. They rarely factor in those premiums, although quantifiable, into the mortgage / risk balance.
Risk is reduced by having lower debt.

People in business know this, those who are not, tend to not entertain the thought. Banks market debt. Borrowers buy it.
The risk topic never makes the table.

Conan,
I will have to disagree with you to some degree. I believe as you put more money towards owning (although you never truly own it) your home, it gets riskier and riskier. What if you need that money? Also, you are forgoing on the chance to earn interest on that money.

Conan,

You have a point, but if one doesn't have $150K for a house, and wants to buy one, he or she has to borrow money. If you have to borrow money, wouldn't it be nice to get a break on your taxes as an added benefit?

You have to live somewhere, right, so if you can get a mortgage that is equivalent or less than your rent would be, you would be ahead after your tax deduction.

Paying a mortgage off early can be a way for one to feel more secure. However, I believe that sow is right on this one. The bank has chosen to share the risk with you on this house by lending you money after determining that you were an acceptable risk. Once you pay off the mortgage, you are no longer sharing any risk with the bank.

Look at this mortgage credit crunch. The banks are in some cases decreasing the principal owed so that they can keep a house out of foreclosure.

Here's another thought for you:

What if you are the sole owner of a bank? Wouldn't you love to pay $10K to your own bank and then take a $3K tax deduction also? I know I would. In fact, I would get an interest-only mortgage and always owe 100% on my house so that every payment (which I'm making to my bank, hence, keeping) is deductible.
So instead of paying $10k, and getting $3k back, I'm paying $10k, keeping it, and getting $3k back.
$13,000 > $3,000

Of course, you have to own a bank. Or do you???

I paid off my house last year and just the thought of debt free is a joy. My neighbor thought that was stupid to do something like that. He could'nt understand that I didn't take equity out and invest it. well I did it for peace of mind and he forclosed on his home,got divorced, and heard he is living in a park area. I have a nice fire going tonight and sleep like a baby!

Great discussion, and very intersting points from both sides of the fence. We paid off our mortgage (never could take advantage of the tax deduction) and now utilize the "extra" money to invest for our future. 50% of my paycheck now goes into my employer sponsored 401(k) and more goes into a Roth. Easy to keep track of and report on, and that works well for me. I won't lose my house in this crazy housing market and faltering economy, and that peace of mind is WELL worth the extra I could have made investing my money some other way.

Kudos to those who have paid of their mortgages who are the true american dreamer.Some great advise been offered here.I support the post on where some folks purchase larger homes that anticipated you are extending your finaces for mere square footage I have many friends who have done and then take another loan to get the furniture and appliances.Many of us spend as if there is no tomorrow.We are still living with the mentality of the 60's where you got a nest egg and healthcare for rest of your life.Wake up folks provde your own nest and eggs.The perks of the past will no longer be a part of the future. I recall advise been penned about using a mortagage for tax break and investing extras to gain more in income but it is a risky venture considering today's crash and turmoil on Wall St.If you are wise you can use your mortgage wisely to make gains.We purchased a home in 94 and an investment property in 2001.Every month we paid extra on the mortgage of both homes.In 2002 I refinanced taking advantage of the low rates and paid of the investment, I subsequently purchased another for cash. After upgrades I sold the first investment and paid off my principal mortgage in 2007 with my profits. I then purchased another investment property using the rent I get from the second property I paid cash for.Think smart. The Mba's and bankers sometimes give risky advise I lost much in the bull run in the early 2000's and not paper money solid cash.To me the stock market is a game.I know if myself or wife losses our job we have no mortgage to worry about.We have invested in 401k and are tracking the losses daily. math is a easy subjectif you can do the numbers and as we know many of us are not good with math.The mortgage payoff is better since you can invest and save your salary and diversify your gains but today it is a lost dream that is making it in investments on wall st.

A lot of very smart people agree with your decision to become completely debt free. I will be paying my house off at the end of the month. I turn 47 in February. Hope to retire by age 57.

I am always amused at the people who tell me I am making a financial mistake by paying my house off early.

Lots of people have pondered the debt topic over the last few thousand years....


Proverbs 22:7

"The rich rules over the poor, and the borrower is servant to the lender."


Thomas Jefferson:

"And to preserve their independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude."

Ralph Waldo Emerson:

"Wilt thou seal up the avenues of ill? Pay every debt as if God wrote the bill."

"A man in debt is so far a slave."

Benjamin Franklin:

"Tis against some men's principle to pay interest, and seems against others' interest to pay the principle."

"Rather go to bed supperless than rise in debt."

Publilius Syrus:

A small debt produces a debtor; a large one, an enemy.


Congrats on being debt free. I look forward to joining your club in about 15 days.

Paying it off is the way to go. Congrats

Where is John K now that the market is down?

I'm 56 and just paid off my mortgage. It definitely gives me a strong sense of freedom and security. It's amazing how many people tell me MOST people do not have their mortgages paid off at my age. Anyone know if this is true? Irregardless, I'm loving it.
I wish I would have done it earlier.

Susan in Ohio

It doesn't have to be all or nothing. It's a good idea to pay down the mortgage AND invest, both in moderation.

This was posted by John K. in January 2008: "Your house will appreciate in value no matter how much you owe on your mortgage... If you want to be wealthy, debt is your friend..."

The last 1-1/2 years have demonstrated that it is unreasonable believe those two fundamental assumptions are always true. I think the assumption that "houses always appreciate" was one of the two largest factors that lead to the inflation - and POP! - of the housing bubble.


I'm going to pay off my house in five weeks. Not only will I FEEL more secure about my financial future I will BE more secure.

Can't wait for September 11 - that's the day I pay off my house!

Good for you, Bob! Congrats!!!!

Working on paying mine off. then I'll have another 2,500 a month to invest in my retirement. Sure I'm behind on the long-term investing at age 36 but I should pay mine off this year. With no interest that's 600k in 20 years without interest. Reading the earlier posts before the burst is funny(sort of) now that every one has lost 50% of their 401k. Nobody knows.....

John K is a moron.

We did it. We paid it off last Friday.

So far it hasn't sunk in, but when I don't have the write the check to the bank this week I think I'll finally realize the magnitude of it.

We made it!

Bob S. --

Congrats to you!!!!!!!

If you'd like to tell your story in a guest post (how you did it), drop me an email.

It's easy. Like the man said, work hard, live cheap, save your money, avoid debt, and don't pay attention to all those Junior Achievement business majors who had all the answers and but are sucking canal water right now.

I got a cheap house (my first) and paid off a 15 year mortgage in 11. Now, I'm living on half my salary, saving the rest, and getting ready to retire early.

I paid off my mortgage three years ago, at the age of 34. Reasonable sssumptions about the future are fine, but they're still only assumptions. Life without a mortgage means my emergency fund doesn't need to be as big because I don't have to save up 6-12 months worth of mortgage payments. Life without a mortgage means I have far fewer financial worries. As others have posted, my net paycheque amount is suddenly huge because two-thirds of it is not already committed to paying off debt. I have many more options to save, to invest, to travel, to renovate, to entertain and to pursue educational opportunities. I have never once regretted paying off my mortgage because ridding myself of that debt meant throwing off the yoke of financial slavery.

Proponents of maintaining debt and investing in the stock market must always assume that the stock market will go up, that jobs will always be plentiful, that they will never be sick or otherwise unemployed, that marriages will not fail, that children will always be healthy and that the big shocks of life will not interrupt the "reasonable assumptions" underlying the wisdom of investing in the market.

Once a mortgage is paid off, there is less financial stress and risk in life. I'm not saying this is a panacea for life's big shocks, but dealing with those shocks is easier when you don't have to worry about paying a mortgage or other debt.

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