I'm on record as being a fan of having no debt. Most people agree with this position as it relates to consumer debt, but once you get into paying off your house, that's where things get a bit messy.
I paid off my mortgage and recommend people doing so under certain circumstances (such as not neglecting other sorts of savings/financial priorities.) I was reminded of this issue (being sure you save in other places before paying off your house) by this Smart Money article on being debt free. Near the end of the piece they say:
Struggling to stay debt-free or to become debt-free can also lead to problems when you do so at the expense of saving for your future, says Elaine Morgillo, a certified financial planner based in North Andover, Mass. Continuously deferring savings — or dipping into them — to maintain a debt-free lifestyle could lead to serious financial woes come retirement.
"You can't exactly go back and say, 'I'd like to make up that retirement contribution from two years ago,'" says Schatsky. In other words, when tackling debts be sure to tackle other goals, like saving for retirement, at the same time. It may be the best way to ensure that you aren't looking for a loan during your sunset years.
I agree. That's why I detailed my thoughts on when you should pay off your mortgage. You MUST save for other items first. And if you can control your spending enough to save and pay off your house, then that's great!
In addition to the SmartMoney article, the first two comments to it contrast the opposite opinions in the "should you pay off your mortgage?" debate. Here's the first, representing the "don't pay off your mortgage but invest the money instead" argument:
Being in debt means I pay $7,000 per month in interest on all my loans, and it also means I make $13,000 in income from that debt. If I paid off all the debt, I would be making $0 off of it. Which is better, $6,000 net or $0? Keep living debt-free, someday you'll be 1/3 as wealthy as I am.
Ok, he's kind of snotty, but you see where he's coming from.
Here's the second comment from the "pay off your mortgage now" camp:
Would you borrow on your house to invest in the stock market? Probably not. That's basically the same as waiting to pay off the mortgage and investing in the market.
Interesting concept/thought.
So, what's your take on the issue?
The "pay off your mortgage now" camp seems a little extreme. Assuming one has a steady job and an emergency fund, mortgage payments can be made from your take-home pay. If you pay extra, you can't get the money back (in case of an extended emergency) without taking out a HELOC. If you had put that same money in a taxable investment, you could just sell some of it.
The big problem with "pay off your mortgage now" is the deferral of all taxable investments until your mortgage is completely paid off. I can't see missing out on market returns (except for what is in your 401k plan) for 5-10 years until you owe nothing on your house. I can, however, understand holding off on investing until a second mortgage with a higher interest rate is paid off.
My suggestion is to take a balanced approach--if you have $1,000 extra in a given month, pay $500 extra on the mortgage and invest the other $500 (or adjust the ratio to suit your needs). Do the same split with any windfalls you receive. The end result is that you will pay off your mortgage less early (but still early) while still putting some money into your taxable portfolio.
Posted by: segfault | April 16, 2007 at 11:22 AM
I think paying off mortgages first is the way to go.
Obviously, if you are choosing from making 6k from your debt or making $0 by paying off the debt, 6k is the "obvious" choice.
I'm afraid that math doesn't quite work out that way though. It is an oversimplification by looking only at expected returns without looking at the variance of the returns.
Most of the financial products out there is priced according to some risk-free rate. You take on more risks when you buy a risky asset, such as stocks. The return of the stocks is risk-free return + some return for the risk that you are taking.
When your mortgage interest rate is higher than the risk-free interest rate, it makes the other financial products a lot less attractive. From your point of view, the risk-free rate is the rate that you borrow with! This means you get compensated *less* for taking on additional risks.
Like the second part of your post, you don't borrow money against your house to play the stock market.
Posted by: Edmund | April 16, 2007 at 11:44 AM
I'm sure that lots people do fall into neither camp absolutely. Maybe it is more balanced to pay off the mortgage a bit early and invest at the same time. It certainly seems more diversified.
Posted by: plonkee | April 16, 2007 at 12:41 PM
I'm pretty much in the 100% invest your money camp absolutely. I'm sure there are situations where I wouldn't be (i.e. you have a really, really high mortgage rate), but they are few and far between.
"Would you borrow on your house to invest in the stock market?" Betting on the stock market with a one year outlook? Heck, no.... Betting on a diversified portfolio over 30 years to earn more than the 4.5% that I'd save paying off my mortgage? Heck, yes... A lot of people talk about the risk of the stock market, but over a 30-year span that's really not a factor. If it is, we are all in trouble with our 401K and Roth IRAs.
The think of "Would you borrow on your house to invest in the stock market?" is essentially twisting the situation where it seems like you are risking your home. This is indeed, not the case with this situation.
Posted by: Lazy Man and Money | April 16, 2007 at 01:59 PM
My wife and I have been homeowners for seven years. Instead of paying extra toward our mortgage, we've invested that money in stocks (above and beyond our tax-deferred "retirement" savings).
Through our investement returns, we now have 3 times the amount we would need to pay off our mortgage.
If we had paid the extra into our mortgage, it would not yet be paid off.
Does that mean in 23 years when we make our last mortgage payment we will remortgage our house to invest the money? It depends on interest rates, of course, but the simple answer is "You betcha!"
Posted by: Randy | April 16, 2007 at 02:47 PM
This is really more about your feelings on debt. Is it a tool to help you gain in the future? Or is it a curse - a mark of servanthood to the lender.
I'm in the 2nd camp, and am aiming to pay off the mortgage early. Imagine a day free from slavery to Mr. Bank. I'm imagining and am working towards that.
Posted by: Jim | April 16, 2007 at 02:48 PM
At risk of being "snotty":
Finance is not a matter of feelings, it is a matter of math. I am not a servant to the lender, the lender is a servant to me and I have no intention of paying one penny to that servant earlier than I need to.
Posted by: Randy | April 16, 2007 at 03:41 PM
"At risk of being 'snotty'"
;-)
Posted by: FMF | April 16, 2007 at 03:45 PM
Well, if you pay the lender off early, you will be paying your servant a lot less in the long run.
Posted by: suze | April 16, 2007 at 07:07 PM
To be honest, I have NO idea. I'm learning a lot from viewing your blog though.
Posted by: tanyetta | April 16, 2007 at 07:08 PM
I am definitely in the "Pay off the mortgage" camp, but not at the expense retirement and other investing.
Here is what I would add :
1. I am missing something......If the first commenter had his debt paid off, wouldn't there be an extra 7,000$ a month? I know we are oversimplifying here, but you risk 7,000$ to get 6,000$. If you didn't risk the 7,000$ a month, wouldn't you have 7,000$ with absolutely no risk?
2. I would suspect that as markets change the risk of getting damaged or bankrupted is pretty high. It only takes one horrible house flip or market crash to send the investing with debt plan into a tailspin.
3. I would also argue that the freedom from owning your own home is also a factor in the equation. Not making payments to anyone gives you clear vision and freedom to do with your money as you please. Stresses are gone for the most part, which leaves you the freedom to be more creative. Debt and the stresses of the juggling act that come with it are usually stifling. It can destroy relationships, can cause bad choices, and a host of other side effects.
-Rock
Posted by: HappyRock | April 16, 2007 at 08:57 PM
I'm a financial professional and this is a no-brainer. You want a nice cheap mortgage for as long as they will let you have one. It is the cheapest money you can borrow and it is tax deductible. For a detailed explanation I suggest you check out Ric Edelman's "The new rules of money".
Simply put, cash is king. Money put into paying off your mortgage is money you don't have access to, and that could be dangerous in the case of an emergency. For example, if you lose your job, you have no cash. Without a job, they probably won't let you refinance because they don't give loans to people without jobs. So in the end, they foreclose on your house even if you have a large chunk of it paid off because you can't make the payments - Exactly what you were trying to avoid! Or you take out a home equity loan at a horrible rate or some equally bad solution.
Another thing to figure into the equation is housing interest is tax deductible. So that 6% loan on your house ends up being closer to 4.3% actually out of pocket if you are in the 28% tax bracket. So the simple math question becomes, can I make more than 4.3% on this money that was loaned to me so cheaply? Heck you can invest that money in a money market or even some savings accounts right now and earn more than that relatively risk free.
Seriously folks, this is a no-brainer. A study was done showing that most millionaires who could easily pay off their houses have 30 year mortgages. There is a reason these people are millionaires and the people who pay off their loans early are still living paycheck to paycheck.
So, the suggestion is, don't put that extra money towards a house payment that is extremely illiquid and only earns you about 4.3%, put that money instead into an investment that earns you more than 4.3%. It's hard to argue with math and risk free returns...
Posted by: Maury | April 17, 2007 at 12:07 AM
And to add to the comment above, I must STRONGLY disagree with the person who stated rhetorically, "would you borrow on your house to invest in the stock market?"
Fact is, everyone with a home loan is currently borrowing from the bank to invest in the real estate market. It is not that much different, other than two very important factors.
1. Real estate returns have historically been significantly lower than stock market returns. (So, you're home loan is a loan to invest in a historically worse performing asset class.)
2. Currently, housing prices are ridiculously high. The run up over the last 7 years is like nothing real estate has ever seen. It is the inevitable truth that housing prices will "revert to the mean" as financial professionals like to say. A correction will likely be taking place.
So the phrasing, "would I borrow on my house to invest in the stock market" isn't exactly correct. Fact is, you are borrowing, and you are borrowing to invest in an asset class that will in all likelihood perform MUCH worse than the stock market in the near future.
I refer you to Yale professor Robert Schiller for further interesting reading on this topic. Links to his articles can be found on the excellent site www.patrick.net.
It's good everyone is discussing these things. It is not often there is a right or wrong answer in finance. (I fight with asset allocation decisions all the time, who knows what is right!) On paying your house off early though, there is a pretty clear, well supported choice.
Posted by: Maury | April 17, 2007 at 12:31 AM
Another thing to figure into the equation is housing interest is tax deductible.
Only if your itemized deductions exceed the standard deduction.
Money put into paying off your mortgage is money you don't have access to, and that could be dangerous in the case of an emergency
Responsible financial professionals advocate establishing an emergency fund of six months living expenses before either investing in equities or paying additional payments on the mortgage.
It's hard to argue with math and risk free returns...
If you know of an investment that provides risk-free returns, please tell us about it.
Posted by: Suze | April 17, 2007 at 10:04 AM
I am not in the mortgage payoff category and it has nothing do with my feelings on debt. I despise debt.
I have meditated on this a lot as this discussion comes up often. & for me there are a couple of distinct reasons, not mentioned above.
For one - we bought our first home at 22. This discussion is completely different if you buy a home in your 40s vs. your 20s, what your goals are, etc. My retirement goal is age 67 or so. So my investment horizon today is 37 years. Closer to 45 when we got our first home. This knocks out a lot of the uncertainty of the stock market (plenty of time to recover from a bad fall), and also puts aside any fears of still having a mortgage in retirement.
Secondly, for now we are barely maxing out our retirement vehicles. These are tax-deferred vehicles. They win over mortgage payment by a mile, financially. I think it can get a little more iffy when talking about taxable accounts, but retirement investing is a whole other story. All the money we pay to the mortgage is tax deductible, and with the ROTHs all our investment earnings are tax-free. win-win.
Thirdly, 90% of my net worth is my house. We only owe 1/3 the value. We live in a very pricey area and sunk a lot to get into a house, and have earned a lot of equity in a short time. I sleep much better at night investing my money, rather than sinking it into our house. We have sunk so much money into our house, I feel it would be foolish to put all of our eggs in one basket. My house could flood away in a storm, but not my investment portfolio. Investments feel like a safer bet overall. They have their ups and downs but seem pretty resilient over the long haul. Back to my #1.
Mostly, we prepaid the mortgage more heavily in the earlier years and I really regret having less liquidity today. I don't like debt, but that also means I like a high amount of liquidity so I don't have to resort to debt. I guess what it comes down to for me.
Posted by: Teri | April 17, 2007 at 03:18 PM
I'm trying to save for the my retirement while paying extra towards the house. Not every extra penny goes to the mortgage, but at least $100-$200 extra per month. When we get a windfall (such as a bonus or refund) then that goes towards the mortgage as well. Right now, our mortgage is our most expensive debt.
Posted by: Blaine Moore (First Time Home Owner) | April 17, 2007 at 03:31 PM
Provided you have an emergency fund (need this before doing either) and can manage your money, investing in a higher interest vehicle is a better move provided you get the return. If you have $1000 to put somewhere you either get your mortgage rate (~6%) or a market return (~8%-14%). The market is not a guarantee but your house value could drop too (unlikely either will drop in the long term). You have the interest tax write off on the mortgage but it is essentially a wash that is absorbed by a higher market return. The only argument for paying the mortgage first is to get ride of a "required" monthly payment obligation. There is something to say for that but means you should by a less expensive house if that is your priority.
Posted by: Todd | April 17, 2007 at 05:08 PM
Suze,
You make some valid points, but none that would be strong enough to sway an intelligent investor into paying their house off early.
You are correct that interest is only tax deductible if your itemized deductions exceed the standard deduction. This is almost always the case though, even for a modest home, but in cases of married couples with a very small house there is the potential to take the standard deduction instead of itemizing. In that case money put towards paying off your house would earn you whatever rate of interest you were being charged for your home loan. For most people, this rate of interest would still be quite low.) Additionally, there is always the potential in the future to write off interest should your itemized deductions surpass the standard.
Yup, people should have a safety net. That doesn't mean that with excess money beyond your safety net that you should invest in an incredibly illiquid, low returning asset. There are much better places for that money than in your home, which is likely going to tank in value in the upcoming years.
As far as products that provide relatively risk free returns, I already quoted Money Markets and banking interest - Both of which are currently earning me a higher percentage than if I would put those payments towards my home loan. Like I said, it is a no-brainer.
Posted by: Maury | April 17, 2007 at 05:48 PM
Why is it that all the people I know who advocate "dont pay your mortgge off but invest" are maxed on on credit cards and the like....?!?!?
Posted by: Vitaly | April 21, 2007 at 01:40 AM
I don't really understand this -- how is paying your home off early not being an intelligent INVESTOR?
Investors have ownership of something. When you purchase stock, for example, you own a piece of a company. To the extent that you haven't paid off your mortgage, you don't OWN the house -- all you have is a debt instrument. To fully realize the equity in the house you have to fully own the house (.e.g., have no mortgage).
Posted by: db | April 21, 2007 at 04:59 AM
Seems to me it's a great time to throw out the word "moderation". I am investing heavily in my 401K, investing in a ROTH, investing in a 529 plan and paying down my mortgage. By balancing all of these, I''m seeing my net worth increase pretty rapidly and also feeling like I'm making good headway on knocking down my mortgage.
Posted by: Hazzard | April 21, 2007 at 01:48 PM
We're maxing out a 401k and two Roths, and will pay off our house in two years. We can't itemize, so the mortgage interest is an after-tax 6.375%. Paying this thing off is a risk-free pretax return of ~ 8%. I really don't think that is too bad, given that we're several years into a bull market that seems to keep going only because people want it to.
At the next big bear market, I wouldn't mind re-financing into a HELOC and plowing some money into equities. Does that sound so bad?
Posted by: CPA1298 | April 21, 2007 at 05:42 PM
Stop paying the property taxes on your paid-off home and we'll see who really owns it! ;-)
I think the argument truly depends upon whether you see your own home as an asset or a liability, what your debt-to-income ratio is, how much you have saved for retirement, kids college etc, and what your risk factor is. There is not black and white, right or wrong answer here: it's really a matter of personal choice.
I for one
Posted by: Ciji | April 22, 2007 at 04:32 PM
"Would you borrow on your house to invest in the stock market? Probably not. That's basically the same as waiting to pay off the mortgage and investing in the market."
This seems rather backwards. Debt can be an asset if used correctly and with an understanding of its impacts. If your mortgage interest rate is higher than what you can earn on the stock market (>~8% on average over long periods, i.e. a 30 year mortgage) then by all means pay it off ASAP, other wise use that cash to buy other assets that will appreciate and leave you with happiness later on.
Posted by: Wall Street Journal | May 05, 2007 at 02:18 PM
If I have a 6% mortgage and have an extra 2000 / month income, what am I going do. I am going to put all of it into my mortgage. Sure it could be argued that I could get an fairly safe 8% return over 30 years, BUT.... dont forget about taxes. If I pay extra into my mortgage, I am not paying taxes on the interest I will be saving on my mortgage. If I invest and get an 8% return a year, I will be paying taxes on that 8%, that means the effective rate will only be around 5.6%. In order to make it smart to invest instead of pay down my mortgage, I would have to get 9%. I personally prefer a guarenteed 6% tax free return (by paying down my mortgage) vs a 9% return with some risk.
Posted by: jeff | June 24, 2007 at 10:39 PM
From personal experience I offer this:
I spent 15 years making extra payments on my 575,000 house to get it paid off early thinking it would provide security in my declining years. 6months afer it was paid off, the was a crack in my pool equiptment that leeked under the house that caused the foundation to crack and shift. fast forward a year later and the foundation had moved so much that the floors, walls and plumbing inside had to be gutted and re done. The repairs to restore the home to original condition exceeded 175k dollars. I didn't have the money and because of the condition of the mortgage industry, couldn't get a loan due to my credit score. I eventually lost the home.
Had i kept 20% equity in the home and invested the rest into the market, I could have walked from the home and still had over 500k in my bank account.
The moral of the story is diversification. Paying off your home allocated all of your eggs in one basket. And in my case, was more risky than the market
Posted by: coot | October 10, 2008 at 02:46 PM
Coot --
Hindsight is always 20/20. You can always make a better decision if you can go back two years and re-do your decisions. Case in point: I'd have removed all my investments from stocks if I knew what they'd do over the last month or so.
Just think -- people who kept all their money in the market (the opposite of what you did) are now moaning because their stocks are waaaaay down. In this case, no one would win.
I agree that you need to be diversified (all of your savings shouldn't be plowed into your home.) I also think that your particular situation -- no mention of an emergency fund and a self-admitted poor credit score -- likely contributed to the problem.
Sorry to hear about your loss, though. That's tough. I hope you're in the process of recovery and I wish you the best.
Posted by: FMF | October 10, 2008 at 02:57 PM
I've read all your comments and both sides have a very strong argument. I've learned alot from reading these comments. However,my house is paid for and man it sure feels gooood!!!!!
Posted by: Storm | November 30, 2008 at 04:14 AM
At the end of 2008, the market is down over 40%. Since I put my money into my home, I feel like I am a brilliant investor. We never had a housing bubble, where I live. Home appreciation has averaged under 3% for decades.
It's funny looking at the posts above about 'simple math'. Most people have earned nothing in the last 10 years in the stock market. I especially like the post about 'most millionaires'. Actually, 'most millionaires' pay cash. It's a fact.
Posted by: Kev | December 24, 2008 at 06:48 AM
@Kev-
Do you have any references for your claims? Specifically for these two statements:
"Most people have earned nothing in the last 10 years in the stock market."
" 'most millionaires' pay cash. It's a fact."
Saying something is a fact does not make it so.
Feeling brilliant and being brilliant are not always the same. Dave Ramsey's plan makes people FEEL like they are taking control of their finances, but in reality, they are often making poor financial decisions.
Would you still have put money into your home if you lived in Vegas? Would you still feel brilliant?
Posted by: Kev | December 24, 2008 at 09:18 AM
@Kev-
Someone above suggested Ric Edelman's "The New Rules of Money". One of the points he makes is that your house appreciates regardless of what you owe on it.
So if you put money elsewhere, your house will still appreciate, and if you put your money someplace safe, it too will appreciate, whereas paying off your house and all of your money is tied up in your house, your gains are set at the appreciation of your house, which you have no control over.
I've done a poor job explaining this concept, but I feel like you might be interested in hear Ric's viewpoints. I was able to download his book from my local library and listen to it on my MP3 player. (Free!)
Posted by: rxjohnk | December 24, 2008 at 09:23 AM