Over a month ago, I published an article discussing whether we should pay off our mortgage early. We are getting to a point where we will max out our retirement accounts (401k, Roth IRA's) and have a significant amount of extra cash every month.
We are trying to figure out if we should focus on paying off our mortgage early or invest in the stock market.
I suggest taking a look at that article for background on the different options we are considering. Here is a summary of the three options:
- Option #1: Pay the minimum amount of $1,525 on our mortgage and invest the rest into index funds. This amount doesn't include insurance or taxes.
- Option #2: Split the extra money between the stock market and paying off the mortgage early.
- Option #3: Focus 100% on paying off the mortgage early every month. We would have the mortgage paid off within 5-years.
Going into the discussion, I leaned towards Option #3 (focus on paying off the mortgage early). I honestly didn't expect my perspective to change too much after publishing that article.
I've been fascinated by the response from the community, and I learned a ton.
Talking about whether or not to pay off your mortgage early is a deeply personal discussion. There is no right or wrong answer.
Each of us has to decide our risk tolerance, consider our future cash flow, and when we want to retire. And even then, not everyone is going to make the same decision.
For this follow-up article, I wanted to create the ultimate guide on the benefits and cons of paying off your mortgage early and tackle the most common reasons people like or dislike each option. This is a lengthy post at almost 5,000 words. You've been warned. 🙂
Community Input Regarding Paying Off the Mortgage Early
The community response was greater than I thought it would be. I was ecstatic to see people voicing their opinion, and the results are more interesting than I anticipated.
Paying Down Mortgage Early Poll
As part of the original article, I provided an opportunity for people to vote on which route they thought was the best option for our situation. A total of 47 people voted in the poll over one month (when the survey closed).
Below is the final results after the poll closed one month after publishing the article.
- 17% voted for Option #1 (8 votes)
- 36% voted for Option #2 (17 votes)
- 47% voted for Option #3 (22 votes)
Over 83% of people thought we should put some money towards paying off the mortgage early.
Maybe this is from the FIRE audience that came from my Twitter followers. But given that I've heard that paying off your mortgage early is the unpopular opinion, I expected more people to vote for Option #1. But maybe this is limited to my social circle.
The 36% who voted for Option #2 show a good chunk of people who don't want to 100% ignore the market over the first 5-year period. Very interesting indeed!
Here are some comments that people posted on the original article. This order matched when they posted.
The main question that I asked was this: If your house was paid off, would you take out a $300k mortgage so that you could invest it? If you wouldn’t, then you probably should pay off the mortgage.- Nathan @ Life Before Budget
I wholeheartedly agree with Penny Pinching Ninja that the psychological benefits of not having a mortgage are huge! But specific to your situation, I know you said you want to take the emotion out of it, and I get why, but I think it’s actually a super important factor here.- PhiaFreedom101
We paid off the second home because we were not certain about the future of our jobs, wanted a psychological boost by being debt free, and were already investing above average (but not like superstars). Now we have the option to invest like superstars, have the option to have a second child and afford daycare, and we just feel good. – Savvy History
It really is math vs psychology. I struggle with this same dilemma. So far I have chosen #2. I was thinking when my brokerage account value equaled my mortgage I would just pay off the mortgage balance. But the closer I get to that crossroads, the more I realize I don’t think I will be able to pull the trigger because I like the liquidity of that large brokerage account earning market returns. I still aim to have my mortgage paid off in < 10 years.- Shawn @ The Smart Fi
Great “problems” and well thought out options. I’d pick a 4th option. Refi into a 15 year and pay the minimum. Stockpile funds for college. Great post! –Tim
A common element with those who wanted to pay off the mortgage early was peace of mind and the lowered monthly expenses.
SusieQ to the rescue!
Susie Q contacted me about writing an article that took a more in-depth look into math. She has a much deeper understanding of the calculations, and I found it enlightening to see how the numbers turned out for each option. It took some time to understand exactly how the math worked (yes, I'm a programmer that is not great with math, lol). But at some point, the numbers and the concepts started to make sense.
Reframing the Paying Off Mortgage Early Discussion
When I was thinking about whether or not it made sense to pay off the mortgage early, my mind kept coming back to how awesome it would be not to worry about the $1,525/mo mortgage payment. And looking at the community response, I'm not the only one that focused on this benefit.
That is a significant amount of money, and it would be fantastic not to have to worry about that expense.
However, what Susie Q made clear was that we have a high likelihood of paying off our mortgage loan under any of the three options outlined in my post, whether we invest or pre-pay over that same time frame (if that is what we decide to do).
The question turned from whether or not we should pay off the mortgage early to which option will lead us to the strongest financial position in 10-15 years.
Let's take a closer look at comparing Option #1 vs. Option #3.
It's All About Options
The money we use to pay off our house is not liquid until we sell. If the market ends up tanking, we will want to get into the market to capture those gains before it recovers. But if we ignore the market and focus on paying down our mortgage, we limit the returns from that money to only saving the amount of interest we would pay on the mortgage.
We also have to consider that saving the $1,525/mo expense is not limited to Option #3; we should have the option to pay off the mortgage early with all three options.
And I'm not saying we are eliminating the option to pay off our mortgage early. Still, by focusing on Option #1 (investing all extra capital into the stock market), we provide ourselves more flexibility in what to do with that money. And we open up the possibility that we could end up making more money.
There is also the option to switch between both options at any point if there is a compelling reason to do so. But I'm becoming more hesitant to use our monthly income to pay down the mortgage directly, as it does limit our options and reduces the opportunity for that money to grow larger.
The amount of money in our taxable investment account will grow from our monthly deposits, appreciate (hopefully), and grow from dividends. The amount we would save in our monthly expenses having the mortgage paid off will be made up with how much this balance grows on its own (especially as it gets larger after a few years).
I mention this because when people talk about paying off their mortgage early, reduced monthly expenses are at the top of the list.
However, even if we do not pay off the mortgage early, we do not give up the benefit of not having that $1,525/mo mortgage expense. We are just redirecting where that money shows up and opening up the possibility of making more money.
Eliminating the $1,525/mo expense in our monthly budget within 5-10 years is less of a concern for our scenario, which transitions well in talking about cash flow.
If we end up retiring early, we will want to reduce our monthly expenses. But given that our cash flow is not a significant concern for the next 5-10 years, we are fine budgeting for the $1,525 minimum mortgage payment until we figure out what we want to do.
“But Chris, what if your situation changes?”
And this is the beauty of Option #1. If we wanted to pay off the mortgage in 5-years, we would likely do so.
If we extend this timeframe to 10-years, which is when we are considering downsizing, our mortgage balance will be less ($221,437), and there is little chance we won't have enough money in our taxable account not to cover the mortgage (if that is what we want to do).
And I want to repeat this point because it took time for this to sink in for me. If our situation drastically changes, where cash flow becomes an issue, we have the option of liquidating part of our taxable investment account and paying off the mortgage at any point after 5-years.
Of course, we may not know we will have a severe cash flow problem until it is smacking us in the face.
But there are several factors to consider. Both Andrea and I work, and the chance of both losing our jobs that we can't replace in some capacity is low. My skills transfer to other jobs (I can work with Drupal, WP, PHP applications, JS, etc.), and I doubt these positions will vanish at the same time. Assuming I keep my mental faculties in place, my vision, and don't lose my arms, I should be able to continue working.
What is interesting with focusing on Option #1, as Susie Q points out, the longer we are in the market and don't sell, the less likely we will lose money on our principal. As the balance grows, it will be easier to absorb the stock market's ups and downs.
The more I thought about this, the more I realized this taxable account is like growing a cash cow. The bigger it gets, the more income it will produce, and the more compound interest will play in generating more money.
Stock Market Risk
My biggest hesitation with Option #1 is the risk of having so much money in the stock market. If we decide we want to pay off the mortgage in full in the future before we sell, I was concerned that timing the stock market could end up making this not a smart move.
But the benefit of our scenario is that our timeline is flexible.
For example, if we decide we want to get rid of the mortgage after five years, and the market is way down at that point, we can adjust our plan to wait things out. As long as our timeline stays flexible, and assuming our income is stable, we can adapt our timing as necessary. Or we could sell the house at that point and avoid touching our taxable investment account (like getting a new mortgage for a new house if we want to downgrade).
And then I started thinking about the downsides of Option #1. What scenarios could happen that make not paying off the mortgage early suboptimal?
Let's assume the market starts to tank in early 2020. Wouldn't that be bad? Not at all! That would be a good thing, as it increases the gains when the market recovers. But what if the market continues to tank drastically over multiple years? It is still a great thing for our investments; it just means that it will take more time to recover. When things start to shoot up, the gains will start piling on.
The main risk with Option #1, from what I can tell, is if the yearly stock market average returns less than the interest on our mortgage, we will have less money (as Susie Q points out). But I think this is unlikely, especially if we extend our timeline to 10-15 years. Even if this was to happen, it might mean we have to wait for another 5-years. And by going with Option #1, there is a good chance the stock market could return much more than 3.625% per year.
Also, by being in the stock market 5-years sooner with Option #1, we reduce stock market risk. The longer you are in the stock market, the more likely you will hit the historical average. Given I “think” the market is currently towards its peak, I want to make sure we capitalize on the gains when things start to tank.
It's weird saying that I want the market to tank next year, but it's the truth. I don't want our economy to suffer; I just want more gains from our investments. 🙂
To illustrate this point further, here is an excellent illustration of a sample scenario where someone invested at the exact wrong times in the stock market, through multiple bear markets. He still turned out okay with his investments ($184k to $1.1m), but if he implemented Dollar Cost Average the whole time, his results would have been much better.
What if Bob dollar cost averaged the entire time, between 1972 and 2007? He wouldn’t have had $1.1 million. He would have had over $4 million in his portfolio in 2018.- ERIC ROBERGE
Susie Q also addressed this issue in her timing analysis.
But what if the market goes to $0?
If this happens, I don't think I am going to be too concerned about our net-worth. The only way to prepare for this kind of situation is to stock up on necessities at our house (long-term food, water, essentials, etc.). Having a paid-off mortgage is probably not going to be an advantage in this situation.
The only guarantee we have regarding the stock market is that things will fall and things will rise. I'm not going to risk a ton of capital, hoping that one stock will increase. But I'm willing to risk that over the long-term, the stock market as a whole will go up. This might mean an extended period where things go down, but I believe our economy can recover those losses, given enough time.
Even when looking at an uncertain future for our economy, I'm confident we can work through whatever happens and come out stronger.
What about saving on mortgage interest?
One of the benefits of paying off the mortgage early is we would save on the amount of mortgage interest paid through the full term of the loan.
It is true that with Option #3, we would save a large amount of money on mortgage interest by paying it off early. Going this route, we are locking in those savings.
However, as I mentioned above, I am now looking at our taxable investment account as a baby cash cow that will multiply our investments. It is like an income generator. The larger it grows, the more compound interest will work in our favor.
Saving on interest, and lowering our expenses, does not create a cash cow. I'm not saying it is a bad/stupid move, but how much benefit we see by doing that with our month to month income is limited and set in stone.
By focusing on our taxable investment account, we can utilize that extra 5-years of being in the market to build this balance faster. It should get to a point where it would generate income that matches our monthly mortgage expense, but it will far exceed that number as the balance grows.
Chris: Do you think you are that disciplined to stick to the plan?
One risk with Option #1 is whether or not we can stick to the plan. With Option #3, once I pay down the mortgage principal, it is much harder to liquidate that investment.
If we go with Option #1, stick with it for a short time, and end up wasting that money (new cars, expensive 4k HDR TVs, more expensive house, etc.), this will most likely wipe out the gains going that route.
We also need to consider human psychology. How will Andrea and I respond to seeing our investment account getting into 6/7 figures? Will we start to feel “rich” and start spending money like we are a Kardashian? If/when the market tanks, are we going to sell amidst the panic?
I don't know how we will feel looking at a large investment account. But chances are, we're going to feel pretty damn good.
Option #1 is going to require focus and discipline. We need to set up systems that limit the chances we will spend the money we plan to invest every month. An option is to auto-invest into our Vanguard mutual fund on the 1st of every month. Of course, that doesn't guarantee anything, but we are not making that cash easily accessible.
As far as not selling our mutual fund/ETF shares when the market is low, I'm reasonably confident we have the mental fortitude not to make a stupid move. There are a few reasons for this: 1) I realize that the time the market tanks is not the best time to sell; it becomes the best time to buy, and 2) I saw my cryptocurrencies crash, and I didn't sell. Granted, we “only” had $10k invested in cryptocurrencies, but at least I know I have experience with those feelings.
If I notice that I become obsessive about our investment account, I may have to block vanguard through our router and trade in my smartphone for a flip phone (which might not be a bad idea anyway).
Honestly, I think human psychology is the most significant risk with not paying off the mortgage early.
With Option #1, we'll need to keep an active pulse on our spending and make sure we stick to the plan. We also have you beautiful people to hold us accountable!
Re-Running the Numbers
To make this as practical for our scenario as possible, I wanted to re-run some of the numbers to account for our total estimated net worth.
Here are my assumptions:
- For the sake of this calculation, I'm going to eliminate Option #2 and focus on Option #1 and Option #3.
- I want to rough estimate our net-worth after 5, 10, 15, and 26 years (which is the year the mortgage matures).
- I'm going to assume the stock market returns 8% annually. Given the long-term average of the S&P 500 at 10% annual return, I feel this is a conservative estimate, which accounts for inflation. I actually think this might be a conservative estimate, considering we will be heavily pumping in funds into the market every month using Dollar Cost Averaging. I know some people are going to have different perspectives on this. Post in the comments!
- Let's assume we do not sell the house for the sake of these numbers.
- I do not include a tax burden with the taxable investment account.
- I'm assuming our house value remains static at $350k (which we bought it for). Hopefully, it will sell for more than what we bought it for over another 10-15 years.
- This net worth estimate does not include our tax-advantaged retirement accounts.
Susie Q created another spreadsheet for me that goes through the numbers. Below is an image that estimates our total net worth over each time frame.
The values under each column represent our estimated net worth after each time frame (which includes the static $350k home equity value). For Option #3, when the mortgage is paid off after 5-years, the full $5,525/mo amount gets dumped into the after-tax investment account.
There are variables, like taxes, that I'm not considering. Undoubtedly, there will be ups and downs with the stock market, but generally, this shows a good comparison between the options.
Here are a few observations from this table:
- The more the stock market returns on average every year, the more beneficial Option #1 becomes. And the reverse is true. If the stock market returns an average of 5% per year over 26-years, Option #1 “only” returns about $116,000 vs. Option #3. But given that length of time, the historical data suggests that is not likely.
- Assuming the stock market returns more than the mortgage interest (3.625%), our net worth will be higher with Option #1.
- Notice that after 10-years, it is doubtful we wouldn't be able to pay off the remaining mortgage balance ($221,473).
- The longer the time frame, the larger the gap becomes between the two net-worth values, and the less risky Option #1 becomes.
I found this simplified net-worth table invaluable in giving us a birds-eye perspective of the numbers behind each option. We account for our house's value and how the difference in stock market returns affects our net-worth.
What Are We Going To Do?
The more I thought about our scenario, the more I realized that our goal is to try to put us in as strong of a financial position as possible after 10-15 years.
If we pay off the mortgage ASAP with Option #3, that is by far the less riskiest option. But given the average of the stock market over 10-year time frames, there is evidence that investing this money instead has a high likelihood of giving us more money and options.
If the stock market ends up tanking during this time, that is an opportunity to make huge gains using dollar-cost averaging. I keep on repeating this because this is one of the negatives I listed in the previous article.
Is it possible that putting this money in the stock market could end up being a bad decision? Yes. But is it likely over 10-20 years? No. That doesn't mean it can't/won't happen!
Summary of Benefits in Not Paying off the Mortgage Early
The below reasons ended up tipping the scales towards Option #1:
- Given a 10-15 year time frame, I think the most likely “worst” case scenario with Option #1 is that it ends up returning the same amount as Option #3.
- Option #1 does not eliminate the possibility of paying off the mortgage early.
- We open ourselves up to the possibility of earning more from the stock market.
- The longer we stay in our house and pay the minimum mortgage payment, the less risky Option #1 becomes, and we have the opportunity to earn more gains.
- We anticipate our cash flow to continue to be relatively stable for the next 10-15 years, and it most likely will increase. In other words, we are not worried about covering the $1,525 mortgage payment. If it does become a concern, we can pay off the mortgage from the investment account.
- Instead of being passionate about not having a mortgage payment, we redirect that excitement into growing a baby cash cow. Hopefully, this baby cash cow turns into a money-making lard ass!
So this leads to the following question: Will we end up paying off our mortgage early?
Honestly, I am not sure. The numbers suggest that assuming we continue not to have a cash flow problem, we are better not to pay off the mortgage early. If we get to a spot in 10-15 years where we want to downsize, it would be better to sell the house for as much as possible and use the leftover to buy our next home with cash. But there are several other options we could consider (renting out our house, deciding to stay put, etc.). But as Susie Qpointed out, those options are irrelevant in figuring out whether or not we should pay off our mortgage early.
The point is, Option #1 is the doorway to giving us the most options. It is impossible to know what we will want to do in 5-10 years. Things could drastically change. The stock market could end up tanking and then enter an extensive recovery period. Or things could continually go up. But by putting ourselves in a flexible spot, we have the opportunity to change our plans.
As far as the math is concerned, and given our risk tolerance, we think going with Option #1 is the best move for us.
Nothing is set in stone, and we will continue to talk about it. But that is our current thinking.
If it wasn't for Susie Q, I don't think I would have understood the math between the different options. She is a math wiz and is way smarter than me. You should check out her site!
Finally, I'm going to go through the specifics of our plan. Since the previous article, our situation changed slightly as we ended up having to use our emergency fund to cover a hefty tax bill. We have to re-fill our emergency fund and delay the plan by about two months because of that setback.
- Step #1 (Now-July 2019): Re-fill our emergency fund to cover 4-5 months of expenses.
- Step #2 (August – November 2019): Pay extra towards the mortgage so we hit the 20% home equity threshold to get rid of our monthly PMI payment (this would save about $140/mo from our total mortgage payment). This also has the side benefit of saving a little bit on interest and makes it easier to pay off the mortgage later (as an option).
- Step #3 (December 2019): Pay the minimum mortgage payment, and dump the remaining funds into a 100% stocks index fund. What we do after this is up in the air and is flexible. December is the hopeful birth date of our baby cash cow!
I'm currently torn on whether it is worth paying down our mortgage to get rid of our PMI payment (step #2). Instead, I might pay a little extra to pay down the principle and then get the home re-appraised to see if that hits the 20% equity mark. Not 100% sure what we are going to do yet.
We will think about allocating with Step #3, and I'm not confident that won't change. If you haven't taken a look at the @IQbySusieQ article covering the risks with each option, I highly suggest taking a look.
The emotional benefit of having the mortgage paid off early with this scenario is offset by the idea that we can still pay off the mortgage early under all three options. This idea is what caused us to take a closer look at Option #1.
It is hard to say what the stock market is going to do, and past stock market performance is not a guarantee of what will happen in the future. With any luck, we could find ourselves entering the market while things go down in early 2020, which would give Option #1 a huge advantage in the long-term.
Reasons You Might Want to Pay Your Mortgage Early
Our goal was to figure out what option would be best for us. The math confirms that all of these options have a positive outcome in increasing our net-worth, and your situation might have you lean more towards the less risky option. I have not become “anti-pay-off-mortgage-early.” My perspective has just shifted as I was able to understand the math behind the different options better.
To make my perspective clear, I'm not arguing that everyone should avoid paying off their mortgage early.
If you are in a situation where future cash flow is a concern, it might be best to pay off your mortgage early. This could be because you are retiring soon and want to reduce your expenses, or maybe you feel like your job could be at risk within a few years. Or perhaps you want to go with the option that has the least amount of risk.
Deciding to pay off your mortgage early is not something I heard most people “regret” doing except for this guy (this story is an exception that I haven't seen often). There are countless examples of people who don't regret paying off their mortgage. Take a look at this article by Perpetual Money Machine as an example. Each option has different benefits and will end up putting you in a strong financial position.
The more important concept is that you pick a plan that you are passionate about and stick to it.
From our perspective, even if we can't retire until our mid-50's, we still consider that “early retirement.” This timeline means we have around 20-years, where we can be flexible on our goal date. However, this isn't to say we might not try to reach this point in our 40's, but our time horizon is flexible.
In either case, you are comparing two good options that will increase your net worth. The fact that you are considering what to do with your money is a sign you will probably be alright with either option.
What do you think? Are you surprised by where we landed? Based on this article, do you think Option #1 is the smartest move for us? Or do you think I went off the deep end?