How to Pay Off Your Mortgage

Crosswalk has some tips on paying off your mortgage as follows:

• Principle #1: Your Contingency Fund trumps paying ahead on your debts.
• Principle #2: Your mortgage should be the last debt you pay off.
• Principle #3: Investing in your mortgage or the stock market depends on other factors.
• Principle #4: Do not enroll in your lender’s formal bi-weekly payment plan.

My thoughts on these:

1. #1 and #2 really go together in my mind. My order of saving/debt payment would be: emergency fund, 401k up to the point where matching stops, credit card debt repayment, paying off other debts, saving/investing for other future needs, paying off your mortgage. This is how we did it, though we didn't have any other debt than our mortgage when we started the process of paying it off.

2. We didn't have to choose between saving/investing and paying off our mortgage -- we did both. We had created such a gap between our income and our expenses that we had enough to achieve all our objectives at once (though, of course, it is always nice to save even more.)

3. We NEVER enrolled in a lender program. Why would we? It's something that costs money that we can do (and did) on our own for free. Waste of money for us (and for most people -- maybe it's good for those who are not disciplined to carry it off themselves?).

4. A key to paying off your mortgage early is my formula for buying a house.

Comments

[Mark]

What are people's thoughts on low-interest student loans when factoring in "other debts". I have no debt other than student loan and mortgage. One loan has a balance of $6000 at 4.9% and another at $15,000 at 2.5%.

I'm thinking no debt is good debt even if the interest is deductible, but because of the low payments would you recommend paying off the loans as fast as possible or investing some of it.

[MonkeyMonk]

I'm not sure why I would ever want to pay off my mortgage early. I've got about $300,000 left on 30-year loan at 5%. Considering I keep my loan and do other things with my money, even assuming a modest 7% return on my investments that puts me 2% ahead at the end of 30 years. People always complain about how high fees eat a huge chunk of your long-term profits but it goes the other way as well if you're not taking full advantage of your money.

And this doesn't even take the positive tax implications of paying interest into account -- all of which pushes your percentage gain even higher.

[WiseMoneyMatters]

@MonkeyMonk
I think one of the best reasons to pay off a mortgage early is security. What happens if you lose your job? What happens if the stock market crashes (more so than it has)? What happens if you are in a horrible car accident and can't work anymore?

If your house is paid off, any of the above will only affect you minimally (at least financially, obviously not emotionally). You can always make do. As we saw recently, you can't even guarantee you will be able to sell your house in a crisis. In fact, if it's more of a national crisis, you are less likely to be able to sell your house.

Paying off your mortgage secures your future. The line of thinking that you need to take out a mortgage to invest the money in stocks is a dangerous line to walk. Many people got burnt this last year fro walking that line. Though I guess it might not be too bad because the government will likely bail you out anyways.

[john]

MonkeyMonk - You speak of a 7% return. What about 40% loss on your investments? Wouldn't it have been smart to invest in your home under this scenerio?

[MonkeyMonk]

WiseMoneyMatters - In all of your examples I'd rather have more semi-liquid funds to deal with the problem than have all my funds tied-up in a fully paid mortgage. Your statements about the difficulty in selling a house only reinforce my feelings. I don't feel this is necessarily a dangerous line to walk at all. It's called leverage and if handled with responsibility I don't see myself running into any problems at all. Also, thanks for your suggestion but I'm in no need of being bailed out.

john -- Yes, that would be bad but do you honestly believe that over the next 30 years I'll be seeing a 40% loss on my investments? Not likely but if that is the case then we'll all have a lot more to worry about.

[Jim]

I agree with the 4 points from Crosswalk and FMFs comments 100%. I took a slightly different path to paying down my home mortgage but we're now doing so.

The bi-weekly payment plans are generally a wast of money from what I've seen. They charge you around $200-400 to set it up and then often charge a couple dollars a payment fee too. You can accomplish the same net result by just setting up automatic payment of extra principal on your own.

WE want to pay off our home for the security of not having a mortgage and the fact that its a *guaranteed* return. Its true you can make more in the stock market long term but theres no guarantee. Paying down a mortgage is a sure thing with a given return. But overall the main reason is the security and the feeling we'll have when we're 100% out of debt.

Jim

[rwh]

Our 5.75% mortgage is about 10% of our take home pay. So if we lose our job we have many other areas where we can cut back before worrying about whether we can pay the morgage. Of course we have no other debt.

WMM observed that investments can drop 40% in value. So can the worth of your house.

Plus, the "security" of owning a house in full only happens when the mortgage is actually paid off. If it takes 10 or 20 years to pay off a 15 or 30 year mortgage, even with paying extra each month, you have no more security from a cash flow position during that 10 or 20 years than the person who didn't pay extra because your mortgage payment is always due each month until it is paid off, no matter how far ahead you are.

We will make extra payments on our mortgage only when we reach the point we can fully fund our Roth IRAs (currently at $3600/yr, cap is $5500) and have finished putting our kids through college.

[LC]

This post seemed more like "how not to prepay your mortgage" rather than tips on how to do it. We are aggresively paying down our mortgage and here's how we do it.

-Decide how much you can afford to pay extra (After your e-fund, 401k, and other debt are taken care of). We can live easily off of one income, so we are putting all of the smaller income toward paying extra on it.

-Apply directly to principal. Most mortgage statements have a line of how much you want to pay extra toward principal.

-Pay online. This saves a stamp, particularly useful when you make multiple payments (see below).

-Decide when to pay it. Although it's easiest to send it along with your regular payment, it makes more sense to send it in at the beginning of the month. Since interest is compounded daily, paying your extra at the beginning of the month can save a lot. (more of your actual payment goes toward principal).

-Actually do it. Put a reminder on your calendar so you remember to go online and make the payment.

[Julie]

#4 is an incorrect statement. Wells Fargo offers a bi-weekly payment at no charge, they will automate it and you can increase the amount taken at any time. It is called their Accelerated ownership plan.

[JACK]

I know I say this on every repay mortgage thread, but the correct comparison is not just between the interest rate on the mortgage and a theoretical return in other investments. The other comparison to make is the value to you of gaining cash flow flexibility. People so downplay that one and it boggles my mind.

As for the question about student loans, those are ridiculously low rates! Again, I'd raise the question of whether you need the cash flow gains that paying them off early would lead to. But assuming no, and given the relatively low balance of the loans, and their incredible cheapness, I'm not sure I'd be terribly worried about them if you can handle the payments. Mine are at just above 5% and I'm hopeful to pay them off in 12 months. I am primarily doing this because (a) I want to free up cash flow and (b) you can't get rid of student loan debt the way you can other debts. (Besides I'll get the pleasure of student loan debt again when I get married and get to see my wife's balance.)

[JACK]

"WMM observed that investments can drop 40% in value. So can the worth of your house."

I think this comment reflects the difference in attitude people bring. If you view the value of your house the same way that you do a stock portfolio, then sure. But if getting a boffo return on your house is not the primary feature than who cares if it drops in value unless you are planning to sell it. And unlike a stock, a home is something that you get value of out independent of its resale value.

[Mark]

My rule of thumb is to always maintain at least 25% equity in the MARKET VALUE of your home at all times. I agree with FMF about not paying off your mortgage first, but I would still max BOTH my 401k and my Roth IRA before accelerating mortgage payoff. If you maintain 25% equity in the market value of your home, you will be able to undercut the local competition if the need arises to sell quickly at a hefty discount, such as after a job loss in a tough economy. If you have a fixed rate mortgage for around 5%, you should really take advantage of the leverage and put your savings in long term investments like mutual funds and stocks. With few exception, a house only appreciates 2-3% per year, whereas a stock portfolio will return on average 7-9% per year over 30 years.

[Meg]

I'll never pay extra on my mortgages again; I used to pay extra on my home until I bought two rental properties which I have no desire to pay extra on due to maximizing my returns via leverage. Since then I look at my own home differently too. Why would I want to pay extra on a 30 yr loan that is under 6% on which the interest I do pay is tax deductible? I swear if I won the lottery I still wouldn't pay off those loans. It just doesn't make any sense. I'd rather have a million dollars in cash and other investments before being mortgage free.

The only caveat is I want all debt including mortgages paid off before I'm 60. But I'm in my 20s now so even if I never pay an extra dime I'll still reach that goal. If I were older I'd pay just enough extra to make sure I reached that goal.

[Meg]

And I agree with Mark - I'd have to be maxing ALL tax advantaged savings vehicles before paying extra on my tax advantaged mortgage.

[aaktx]

I paid my mortgage off last year and am so glad I did. I view it as a guaranteed return on the rate you are paying. The tax advantage is not so great. You are paying extra money for a write-off? I am 37 years old and will plow the extra money into index funds, averaging in.

[MonkeyMonk]

I paid my mortgage off last year and am so glad I did. I view it as a guaranteed return on the rate you are paying.

This is true and in my opinion a sound financial reasons to pay off your mortgage early if you're incredibly risk adverse. Essentially what you're doing is putting your money into a 30-year CD locked at 5% interest (that's my current rate) but unlike a CD it's even harder to get immediate access to your funds should an emergency arise. A 5% guaranteed return isn't horrible -- I just think you can do better with your money.

[MonkeyMonk]

Oops. That 1st sentence was meant to be a quote from aaktx but my coding must not have worked. The Preview button is my friend and I should take advantage of it.

[rwh]

Jack:

I think opinion and attitude are two different things. I expressed the opinion that a house can drop in value just as much and just as quickly as any other investment. There is plenty of recent evidence to support that opinion. I don't know what you mean by "attitude".

You state a drop in real estate value isn't a big deal unless you're trying to sell your house. I have read the average American house is sold every 7 years or so. Keeping that statistic in mind it makes sense to diversify one's assets (and a house is still an asset no matter what intrinsic valaue it may also have).

I will stand by the sound advice of many financial experts that you don't pay off a low interest mortgage early if it means most of your net worth is then tied up in your house.

And I misapplied the original statement about the 40% drop in investments to WiseMoneyMatters. It was John that mentioned it. Sorry about that WMM.

[Michael]

The easiest way to pay off your house early, IMHO, is to buy a more modest home on a 15 year note. We did this 10 years ago and now have 5 years left. I will be 41 when it's paid off. The higher payment has not hurt our lifestyle at all. The biggest gain I believe we will have is the freedom of being 100% debt free. Some of my neighbors are levereged to the hilt and keep refinancing on 30 year notes. They are so stressed. When my home is paid I really have no obligations to a job I do not like. Think about the peace of mind this provides. That is priceless.

[LC]

I think 30 year mortgages are a "safer" way to go, even if you can afford 15, and here's why:

Assume a 15 yr at 5.69% and a 30 yr at 6.0% on a 100k loan (latest rates on bankrate) and assume that on the 30 year you add enough to the principal to equal your payment on the 15 year. You would pay it off 6 months later and pay ~$4900 extra over the life of the 30 year loan. That is about $25 a month that it costs you just to have the insurance of a much smaller payment should you lose your job or have major unexpected repairs or bills. That's worth it to me, especially now that we are in a recession and perhaps at risk of losing one of our incomes as well as having a baby and maybe wanting to cut back to 1 anyway.

[Todd the Libertarian]

I can't think of a good reason, in the real world, one shouldn't pay off his mortgage as quickly as is reasonably possible. Although folks always talk about the value of leverage, leveraging is what has caused the current credit meltdown. While there certainly is a value to the use of leverage in business, as a matter of personal finance those who are economically self-sufficient (e.g., those profiled in "The Millionnaire Next Door") tend to eliminate debt as quickly as they can.

Indeed, if you were to look at the net worths of everyone who posts on this website (if that were possible), I'm certain you'd find that, in general, those with the higher net worths also have the least debt.

Life is much easier if you are debt free.

[rwh]

Todd:

There is good debt and there is bad debt. In my own situation we have about 56% equity in the house we just bought. We financed at 5.75% for 30 years. Our payment represents about 10% of our net monthly income and we have no other debt. Since we already "own" more than half the house, we're less concerned with paying off the mortgage early than making sure we have enough money to pay for our kids college, our own retirement, an emergency fund, and a fund for planned, major expenses such as cars, home maintenance, trips etc.

It does us no good to have 100% equity in our house if we don't have sufficient funds for the other things I mentioned above. We would just have to borrow, and while we could do that for college expenses, we can't do that for retirement.

I have many libertarian leanings, but I've learned that life isn't black and white. So when you say you "can't think of a good reason" why someone shouldn't pay off their mortgage as soon as possible, I just gave you several. Don't be a slave to ideology.

[Todd]

My being pro freedom has nothing to do with my belief that one should pay off his mortgage with rapidity.

I just find that most people who are financially well off accomplish that status through financial discipline and denial of immediate gratification, and paying off one's mortgage rather than carrying debt ad infinitum is one of things that characterizes that group (in my experience).

Slightly off topic, but I know many people advocate not having most of your net worth in your house. I am 25 and have about $75,000 equity in my house. I have a $15,000 emergency fund. I do have a good amount saved for retirement as well but let's say I had nothing (~85% of my net worth in my house). I am contibuting $30k to my retirement accounts, so by age 55 I will have over $3M assuming a 7% return. I'm confused as to why that would put me in a bad position. (I know that early investing for retirement is very worthwhile, which is why this is only a hypothetical situation).

[Mike Hunt]

My rule of thumb is pay for your house in full as long as it is no more than 20 - 25% of your entire net worth. That means that you have lots of liquid assets besides your house. Once your monthly nut is low (no house payment, no car payment) then you can keep working and have fantastic cash flow. At that point you can invest (gamble, really) in the stock market and take bigger risks.

Are you being conservative by tying the money up in your house? Yes, but the 'interest' you get would be the equivalent rent or mortgage for the place you are living in.

I'm no expert but this was one of the major keys for me to dramatically increase my net worth. Well, that and getting a highly paid job just after I bought my place.

-Mike H.