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In 2004, I bought my first home. I was 23, and I thought I knew everything there was to know about finance. In reality, I had no idea what I was doing. I took out what seemed to be a huge but reasonable mortgage and decided to be aggressive with a fifteen year mortgage in order to lower the interest rate to 3.5%. At that point, I felt mentally prepared to quickly pay off the mortgage.
On paper, it made sense for me to buy a house. I had a good job, had friends in the area and had plans to stay in the DC area for the foreseeable future. Looking back now, 2004 was close to the peak of the market. Had I needed to sell the property in 2010, I would have taken a bloodbath. Luckily for me, I didn’t need to sell the house and was fortunate to stay employed during the Great Recession.
In order to afford the home, I had to bring on three other roommates. While this made for some tight accommodations at times, the rent and utilities checks more than made up for the inconveniences. Four guys in a house has all the makings of a frat house. If you are ever in this situation, write into the contract that a maid service will be coming in every two weeks. This was crucial to ensure the house never became too filthy.
In a Hurry to Pay Off the Mortgage
One of the more controversial moves that I made according to some financial advisors was paying off the mortgage as quickly as possible. Most promote investing money in the stock market instead of paying off your mortgage since historically the stock market has yielded greater returns over time.
I decided even with that knowledge at the time that I would rather lock in and pay off the 3.5% mortgage rather than taking a risk with the market. It made more sense at the time to diversify my portfolio and treat my mortgage as a bond with a guaranteed rate of return. Most financial advisors will advise against this. They say 20-somethings don’t need that much exposure to bonds. I disagree. Since I was able to pay off the mortgage in essentially half the time, I was able to reduce the amount of interest I paid by a little more than $24,500, which in turn equated to a 3.3% rate of return.
If I Had Invested the Money
So let’s say that instead of paying off the mortgage, I decided to invest that money into the stock market. Using Morningstar, if I had purchased the S&P 500 (which I talked about in a previous why I love the S&P 500 article), ticker symbol SPY, back when I bought my house in mid-2004 until I paid off my house at the end of 2012, the total return from the S&P 500 would have been 47.19% with dividends. On face value, that would have been a return of 4.65%, which obviously is higher than the 3.5% mortgage rate I was getting a guaranteed return on.
However, since I didn’t make a lump sum payment to pay off the mortgage in the beginning, I don’t think it’s an accurate measure to use the figures above. In fact, what I should actually use is a dollar-cost average to get my true return. Using the $900 that I averaged monthly paying off my house, I would have a cost basis in the S&P 500 of $92,700 with a total return, including dividends that are reinvested into more shares, during this period of $119,421. This comes out to a return of closer to 3.6% per year, which is similar to the 3.3% return on paying off the mortgage earlier or a difference of $2,781 over the seven and half years.
Tax Implications
What about the home interest deduction? I actually LOWERED my taxes now by not paying interest on my house. The money that I was allocating towards paying off the mortgage in principal and interest is now being used to maximize my 401(k). Therefore, I am actually able to save more in my 401(k), which is growing tax-free, and by not paying principal and interest.
If you are thinking that I should have maxed out my 401(k) AND paid my mortgage payment to minimize my taxes, you are probably right. However, looking at the difference in returns of 4.65% vs. 3.3%, I feel comfortable with the decision I made. While it felt daunting to pay off the mortgage, by the end of 2012, I had reached my goal of paying for my house. Honestly, the feeling of knowing I didn’t have to pay that massive bill each month was an incredible feeling.
Have you considered paying off the mortgage? Why or why not? What would you do with your excess cash if you didn’t have to pay the rent or the mortgage each month? Share your thoughts below.
Wonderful article! I agree wholeheartedly. Paying off our mortgage has added quality of life to our family with the financial stability and sense of security it has allowed. In addition, it has afforded us the freedom to pursue other dreams with the extra money we have saved. One of our biggest dreams is to one day pay cash for a beach house.
D. Rudd – Thank you for the comment. I agree it definitely has added to our quality of life as well.
Keep saving…sounds like a beach house is in your future.
I totally agree with you on paying off the mortgage early. People talk about taking advantage of the low interest rate and the difference in math, but math doesn’t take account of the short-term risks that can happen to anyone anytime (i.e. layoff, medical emergency).
My husband and I are saving aggressively to pay off our house before buying our second house. Finances aside, it will give us such a peace of mind knowing we’re less likely to be homeless should something happen.
Ms. Frugal Asian Finance recently posted…Why I Don’t Plan to Be A Stay-At-Home Mom
Thanks for sharing Ms. Frugal Asian Finance!!! I definitely agree that paying off your mortgage is huge peace of mind 🙂 Speaking from experience it’s definitely one of the best decisions I’ve made.
I agree with paying the mortgage off early. I just hit me 78% LTV and am excited to reduce my monthly payment by 45$ and take my escrow into my own hands!
Diligent Dividend –
That is such great news. Congrats on the reduced payment. Keep up the good work!!!
I finally ended up paying off one of my mortgages 12 years later in 2015. It felt WONDERFUL and I don’t regret it one bit. But I was 2 years late as I wanted to pay it off in 10 years instead.
I think folks should just do both, and definitely max out their 401k/IRA first. Free month, and compounded tax free growth is wonderful.
Now I’m off to pay my second mortgage off w/in the next five years!
Sam
Financial Samurai recently posted…Income By Race: Why Is Asian Income So High?
Hahaha…I have followed your website for awhile now so I read all your articles as you were paying off your mortgage. I love reading your stuff. You seriously have a gift of writing.
I even wrote an article about how you inspired me to start blogging. I really appreciate the time you took to provide feedback on my website.
I think it all comes down to your lifestyle preference. If you want to maximize your net worth over 30 years, then not paying off your house is the way to go. If you want to live life without a mortgage payment and make the decision at that time as to how to invest the difference then you should pay it off. There are huge benefits with both strategies. In a low interest rate environment it is clearly a benefit to your long-term net worth to invest in the stock market. You can then pay off your mortgage and keep the difference. I liked your post! very interesting take on this question. Do you think you would have a different perspective if the stock market had gone up 10x like in the 90’s?
That’s a great question. I obviously had some bias in the market after watching the market recede after the dot com bubble and the 9/11 attacks. Both of which shaped the way that I was investing at the time. I think if I had bought in the 90s that I would have felt more comfortable in the market and probably would have done things different. I really appreciate your thoughts.
You make an interesting point here and it’s a “controversial” one for sure..
Personally I’m not paying down my mortgage (which is an investment or rental property) for tax reasons..
At the same time though there’s great reasons to pay them down including security, building equity quicker etc
A tough one and really up to as Patient Wealth says lifestyle preference :)!
You are absolutely right. The best thing about personal finance is that it’s personal. Each person has difference preferences and what makes sense for one doesn’t make sense for another. For me it’s totally worth it but I totally understand the counter view of not paying off your mortgage. Just thought I’d share a different perspective 🙂
Yes, different perspectives are great and it’s certainly a consideration (paying down the mortgage) that I’ll need to take into calculations 🙂
Cheers MSM!
I would love to pay off our house in 3 years. Not sure if it is possible with $150,000 mortgage, but it would be nice. I just need to get my wife on board (and we would have to work some extra jobs).
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It took me seven and a half years so it was definitely not an easy task. So give yourself some time. But if it’s something that you wanna do, build that financial bridge to how you’re going to get there. I can tell you from the other side it’s totally worth it!!!
I would consider paying off my mortgage sooner if there were no incentives to save for retirement, but there were some really good free money from my employer and the government. I can’t say no to free money, so I use my extra cash to save for retirement and use the tax refund to increase my investments. Kudos to you for being disciplined and conservative. I am too much of a risk taker to pay off my mortgage that soon. However, I am a bit jealous that you don’t have a mortgage now.
Leo T. Ly @ isaved5k recently posted…Part 2: How To Improve Your Financial Health
From what you shared it doesn’t make sense with some of the incentives that Canada provides. Plus you’re a millionaire so you doing something right 🙂
I’m paying mine off rapidly. I really think Dave Ramsey does the best job at arguing why you should. I ask people, what is the difference between paying taxes and paying interest? The answer is “nothing”. Interest rate, stock market return discussions rarely discuss risk. When you consider risk it really starts to even out.
I love having big cash-flow in my monthly budget. So getting rid of the mortgage plus freeing up what i’m using to pay down the mortgage will be an awesome plus up to my cash-flow. The biggest pay raise i will probably ever get.
great article!
ReachingTheCrest recently posted…A Beginner’s Guide to ‘Written Goals’
I’m glad you enjoyed the article. I feel like there are two camps. You either pay off your mortgage because you hate the debt or you say your money would work better in the stock market because of the higher returns. I think it my example I show that the stock market doesn’t always make it such an easy decision 🙂
I had a different approach: from the monthly saved amount I use 30% for loan reimbursements and the rest for investing. I considered that for my current financial situation it is of a higher priority to accumulate capital. With this approach I’ll finsh paying the mortgage in 5 years (I already paid for 10 years).
Each month I am asking myself if I should allocate more for mortgage reimbursement but for the moment I am doing efforts to stick to my plan although I feel some stress because of the risk of having this mortgage. I can’t wait to get rid of it.
Thanks for sharing Mihai!!! Sounds like a great plan and sounds like you are well on your way to reaching FIRE!!!
Before we decided to move, we realized that with our fifteen year mortgage, we would pay off our house the year our oldest was a freshman in college. That would leave us with a lot of cash flow to help him pay for college. Now that we’re planning to sell the house in a few years, I’m so glad we took out a fifteen year mortgage because we’ve built up a lot of equity. If we had paid our house off, we’d be in a much sweeter spot, but I think we took the Middle Road approach between the two camps you mention–we took out a 15 year mortgage and paid some extra on it while still saving a lot in the stock market. So I guess you can say we hedged our bets.
Laurie@ThreeYear recently posted…The Most Romantic Lenten Sacrifice
Awesome job Laurie!!! I love when there is a thought process going on…especially since at times I can go on autopilot and not think about all the possibilities. Sounds like you have things under control are going to be rewarded!!!