In a few months, we are going to get to a spot where we can invest a significant amount of money every month.
I haven't decided what we should do. I understand not paying extra towards the mortgage, and dumping everything into an index fund, will provide more money over the long-term (theoretically). But I wanted to take a close look at the numbers and see how much of a difference there is in our specific scenario.
Thinking about if you should pay down your mortgage and how much to pay is a personal decision, but I want to try to take emotions out of the discussion as much as possible and look at the benefits/cons of each option.
As you can see below, each option has different benefits and outcomes. The good news is that I don't think any of these options is a “bad financial decision.” All options will put us in a strong financial position.
A follow-up article has been posted on what we decided to do with our mortgage going forward.
We built our house in 2015 (we are about 3.5 years into our mortgage). We decided to build a house in a family-friendly neighborhood, with parks, trails and central enough in our town. Building a brand new home ended up being worth the extra cost for us (post scheduled next week that talks about this).
Below are a few informational points that will give you some context in our long-term plan:
- Selling Our House: The soonest we would sell our house would be in 10-years after our girls go to college (this could change). When we do sell, we will probably get a smaller home in a cheaper neighborhood.
- We are about 3.5 years into our 30-year fixed rate mortgage. Our mortgage interest rate is 3.625%.
- We didn't put a tremendous amount into our downpayment. Our mortgage currently has a principal balance of about $310,000, and the loan was for $334,400.
- Our current mortgage maturity date, based on paying the minimum amount is July 2045. That's about 26.5 years from now (we'll use 26 years for simplicity).
- Retirement + Cash: You can assume we are going to do these things in addition to how we decide to tackle the mortgage:
- We will already have around 4-5 months in cash in our long-term emergency fund by the time we implement this plan.
- Maxing out my 401k contribution limit with my employer
- Maxing out our Roth IRA's (one for Andrea and myself)
- Putting away some money into a 529 plan to help with our kid's college
I'm sharing more personal information than I usually do. I know these are some big numbers (rounded for simplicity), and you might be at a much different place in your life.
If you aren't bringing in as much income, or are trying to pay off debt, don't let my numbers discourage you. I want to share the details on our story to be more transparent with the community on where we are at, not to use it to “brag” about what we have.
Each of us is at a different stage in life, and bring in different amounts of income. But the concepts talked about in this article and on this site in general, can be applied to different income levels. You can use these basic concepts to run your numbers to see how they play out in your case.
Reasons to Pay Off Your Mortgage Early
What intrigues me about paying off the mortgage loan sooner than later, is how much our monthly expenses will go down and how much money we will save on interest.
Lower Monthly Expenses
Below is what we currently pay for our home per month, and how much we will save once we pay it off. Note that taxes/escrow payments will probably go up over time.
- Current Home Payment: $2,042/mo
- Home Payment After Mortgage is Paid
- Per Month Savings once Paid Off: $1,525 ($18,300/yr)
I've thought about what we could do in the situation when we no longer have a mortgage.
Not having a mortgage payment is huge for financial freedom and flexibility.
One option would be to rent out our current home and buy something cheaper with cash. This route would bring in semi-passive income every month, and we should be able to rent the house for a decent amount once the mortgage is paid off.
Or we could end up selling our current home after 10-years, and use those funds to buy a cheaper house and invest the remaining amount.
In either case, having an extra $18k per year to invest, is a massive amount of money. Also, since our monthly expenses will go down, this means we don't need as large of a nest egg if we did want to retire early.
Save on Mortgage Interest Charges
In addition to saving on our monthly expenses, we would save a crap ton on interest (compared to paying the minimum amount).
Take a look at this excellent article from Financial Pilgrimage that shows you generally pay 3x as much on mortgage interest with a 30-year loan vs. 15-year loan (at loan maturity). If you make additional mortgage payments, you will save even more on interest. As you will see below, this is a big reason to pay off your mortgage early and how a 15-year mortgage is a great option.
Not having a mortgage means you have much more money to do other things. Here are a few benefits that come to mind:
- The possibility of retiring earlier
- If we wanted to get into real estate, not having a mortgage should make it easier to get into real estate investing
- I have never heard of anyone who regretted paying off their mortgage early
I know Dave Ramsey makes a big deal about being mortgage free, and it makes sense. Based on our current expenses, outside of what we save/invest, or mortgage payment covers 34% of our expenses.
That is a life changing amount of money that becomes available.
What should we do?
I want to hear what you think we should do. I'm not going to guarantee that we will follow the most voted for “option,” but if you can provide compelling reasons for your choice in the comments, that might help tip the scales.
For the mortgage payoff calculator, I used the Dave Ramsey Mortgage Payoff Calculator. I rounded some of the numbers to make them easier to digest, and I tried to summarize where each option would land us over an 8-year and 26-year time period.
Here is also another mortgage calculator that allows you to see when your current mortgage would be paid off with extra payments. The results seem to be close to the Dave Ramsey calculator, but I like how this one gives a more precise estimate in when the mortgage will be paid off.
The 8-year timeframe represents when we would have the mortgage paid off with Option #2. The 26-year period is when our loan would reach maturity. I used these numbers to provide a way in “semi-accurately” comparing how each option changes our overall financial picture.
I know there are some things I'm not accounting for. For example, I'm not considering the taxes we would pay from the amount earned from our after-tax investments. I'm also not taking into account future raises or additional income that will change these numbers.
I also realize that my after-tax yearly growth rate at 8% could be wildly off what ends up happening. I'm assuming 8% per year is a reasonably safe average growth percentage for the stock market over a long time frame.
Financial Pilgrimage made a great point that we could be entering into another recession very soon, and this might be a good reason to not go with Option #1.
Lastly, in either case, we are hoping to retire well before 2045. So even if we went with Option #1, we most likely would pay off the mortgage earlier than that.
To make it easier to understand what each numbers means in each case, I'm defining a few terms that will represent different time periods:
- Phase #1: This is the amount accumulated in the after-tax investment account from year 0-8. Eight years is when we would have the mortgage paid off with Option #2. This amount includes compound interest making 8%/year.
- Phase #2: This is the total amount accumulated after 26-years. This is the point our mortgage would be paid off without extra payments. This amount includes compound interest making 8% per year.
After the mortgage is paid off in Option #1 and Option #2, we would dump the mortgage amount, plus 100% of the extra payments towards our after-tax investment accounts. This would come to around $5.5k/mo
Option #1: Don't Pay Extra Towards Mortgage
In this option, we would not put any extra amount in paying down the principle on our mortgage. The idea is that we would dump the total amount ($4,000/mo) into index funds using after-tax investment accounts, and hope it can grow faster than the interest we would pay on the mortgage (and the benefit in having the mortgage paid off early).
For these numbers, I'm assuming we aren't going to pay off the mortgage early, even though that becomes an option using a lump-sum from our after-tax investment accounts.
I know there is a theory that if you don't pay down your mortgage, that money will not be invested, and be like dust in the wind. But rest assured, we are very motivated and if we went with this approach, you can assume this money would get invested.
Here is how the “not paying extra towards the mortgage” option breaks down:
- Mortgage Loan Paid Off: July 2045
- Extra Mortgage Principal Payment: $0/mo
- Total Interest Paid on Mortgage: $215,000 through loan maturity
- After-Tax Investement Account: $4,000/mo
- Phase #1 (years 0-8): $551,000
- Phase #2 (years 0-26): $4,145,000 (holy shit!)
The numbers here are interesting. The 8-year balance should be enough money to pay off the mortgage in full, as an option.
However, if the market is down at that point, will I want to liquidate?
It is interesting to think about how much our money would grow after 26 years. That is a huge balance!
The biggest concerns I have about Option #1:
- How much taxes are we going to pay for our after-tax account going this route?
- If we do pay off the mortgage with these funds after 8-10 years, how much will this change the numbers? We'll have more equity in our home, but will have paid more interest and I'm guessing it will slow down the growth of those funds.
- Are we focussing too much on the stock market with Option #1?
- What if the stock market tanks and we decide we want to try to retire early?
Option #2: Split the Difference
With this scenario, we would dump around $2,000/mo in paying down our mortgage principal. Going this route means we would pay off the mortgage in 8 years (2027). We also would have around $2,000/mo to put into our after-tax investment accounts, in addition to paying down the mortgage.
Option #2 represents the middle of the road scenario that would give us the best of both worlds. Paying off the mortgage earlier, saving on mortgage interest, and building up our after-tax investment accounts at the same time.
Here is how the “split the difference” option plays out:
- Mortgage Loan Paid Off: August 2027 (8 years)
- Extra Mortgage Principal Payment: $2,000/mo
- Total Interest Paid on Mortgage: $93,000 (57% savings) vs loan maturity
- After-Tax Investment Account: $2k/mo through 8-years, and then $5.5k/mo 8-26 years
- Phase #1 (years 0-8): $276,000
- Phase #2 (years 0-26): $3,772,000
The 26-year balance above represents increasing the monthly investment from $2k/mo to $4k, plus adding the $1.5k per month that would be freed up after eight years when the mortgage is paid off. The calculator for this value starts with the balance from 0-8 years, and calculates the additional investment amount from 9-26 years to generate that total.
This number is surprising because I didn't think it would be anywhere close to what we would have after 26 years with Option #1.
But it seems like Option #3 has the mortgage paid off earlier, and doesn't sacrifice too much gains compared to Option #2.
Option #3: Pay off that Mortgage ASAP!
Option #3 is where we would 100% focus on paying off the mortgage (outside of maximizing the retirement investments above). Going this route means we would pay around $4,000/mo towards paying off the mortgage in five years (2024).
Here is how the “pay off that mortgage ASAP” option plays out:
- Mortgage Loan Paid Off: March 2024 (5 years)
- Extra Mortgage Principal Payment: $4,000/mo
- Total Interest Paid on Mortgage: $72,000 (66% savings) vs loan maturity
- After-Tax Investment Account: $0/mo through 5-years, and then $5.5k/mo 5-26 years
- Phase #1 (years 0-8): $231,000
- Phase #2 (years 0-26): $3,594,000
The same assumptions for Option #2 apply to this scenario. After the mortgage is paid off at the 5-year mark, everything gets dumped into the after-tax investment account ($5.5k/mo).
I'm surprised there isn't more of a difference in the after-tax balance compared to Option #2. That extra amount put into that account after year five appears to make up a lot of the difference.
Out of all these options, this option is appealing for these reasons:
- Mortgage gets paid off sooner, which gives us more options earlier
- We save on taxes while we are paying off the mortgage. With option #1, we would need to pay taxes on all dividend income.
- If we decide to sell our house sooner, assuming we at least wait for 5-years before selling, we don't have to worry about paying a balance on our mortgage
- We are not overly invested in the stock market early on. If the stock market tanks, it won't affect us as much.
If we decide to sell our house and buy something cheaper after 10-years, these numbers start to get interesting. Let's say we were able to pocket $200k by doing this and dumping that into the market at 10-years (this assumes selling our house for $400k and buying something for $200k). That would add an additional $685,000 after the 26-year mark. That would increase our net worth value after 26-years with option #2 and #3 vs. option #1.
After looking at these numbers, it seems the math suggests Option #2/#3 are the best options.
Below is an embed poll. Please only vote one time, so we can get an accurate idea in which options are the most popular. I set this poll to expire after 1-month.
The poll has closed. Below are the final results:
- Total Votes: 47
- 17% voted for Option #1 (8 votes)
- 36% voted for Option #2 (17 votes)
- 47% voted for Option #3 (22 votes)
Our Current Opinion
Before writing this article, I was reasonably confident that Option #2 would be the best way to go. However, after looking at the numbers, I feel like Option #3 might be the smartest move.
- We start seeing results from our efforts earlier.
- By the time I turn 41ish years old, we wouldn't have a mortgage.
- Reduces the amount of tax we will pay while we are paying down our mortgage
- Less dependent on stock market gains in the beginning
- Opens up the possibility of retiring early in our 40's, especially if we can generate other passive income streams
- There is a good chance we could pay off the mortgage in 3-4 years with additional income
However, it looks like we will be sacrificing about $500k over 26-years if we don't go with Option #1. But if we sell our home and downgrade after 10-years, our net-worth could be higher going with Option #3.
I also have a sneaking suspicion I might be missing some significant elements with these calculations. I generally feel like the estimated returns from index funds is a bit inflated.
With that said, we have not 100% decided what we are going to do. Option #1 generates a huge number that grows faster as it builds, and there is a chance we might decide to go that route.
It's interesting to see how much compound interest grows your money once you can invest your mortgage payment. For me, I was shocked at how much we can grow our nest egg AND have our mortgage paid off early. After putting these numbers together, all of these options would be smart financial decisions.
My gut tells me sacrificing 5-years in the market with our after-tax investments is worth it. But I want to hear what you think!
Which option do you think is best? Is my math calculating each option accurate? Do you think I am insane not to go with Option #1?