Should you pay off your mortgage early, or use those additional dollars to save and invest? While the American Dream has been to own a home and pay it off completely, ideally before retirement, is that actually the best strategy? Let’s explore the benefits of a mortgage, why people like to own their home, and how to make the best decision you can.
Can You Pay Off a Mortgage Early?
Sure, you certainly can pay off a mortgage early. Many people choose to do this simply by making an overpayment on their monthly loan payment. This may take off a few extra days or weeks of the loan, which can add up. Some people may also try an accelerated home equity line of credit. However, companies offering to facilitate them often use misleading language to lead you to believe you can somehow do this and save money. Ultimately, these programs just boil down to a more complicated way of making overpayments on your mortgage, which you can do yourself if you really want to.
Should You Pay Off Your Mortgage Early?
While you certainly can pay off your mortgage early, we recommend proceeding with caution. There are a few reasons to be careful, in fact. While you may wish to have the certainty of a home that you own free and clear, there can actually be some hidden uncertainty.
Generally, when people wish to pay off their home as soon as possible, they get a 15-year mortgage. They may even make overpayments on top of that mortgage to shave off some time. This kind of strategy can actually hinder your wealth journey. All the money you funnel into your home can prevent you from building your savings, potentially for up to 15 years. And while you can certainly start saving after your home is paid off, you’ve lost a 15-year lead. What happens if you have an emergency or opportunity while you still have the mortgage? Not to mention, you’re losing out on the opportunity costs of those savings.
(Here’s a technical look at choosing the right mortgage term.)
Aside from this, banks actually WANT you to pay your mortgage faster. But not because it benefits you. It actually benefits them. For one thing, over time inflation is going to devalue your mortgage payment. This is great for you if you hang onto the payment, because it’s going to feel lower and lower as time goes on. For the banks, however, they’re getting receiving money with less value. They offer lower interest rates for 15-year mortgages to incentivize people to “save money,” while also ensuring that they get as much value as possible.
Mortgages During Market Crashes
Another reason banks prefer shorter mortgage terms is because it gives them more control. The closer you are to paying off your home, the more control banks have, in fact. In the event of a housing market crash, banks are less lenient to borrowers who are closer to paying off their homes, because they can recoup more of their investment through a foreclosure. In fact, they may even profit. However, if the market crashes and you just bought your home, they’re more likely to work with you on payments because they’ll lose money in foreclosure.
So while people may feel more secure by paying off a mortgage early, it can put you in a bit of a tricky financial position. And if you don’t have the savings long the way to cushion any rough spots, you may wish you had done things a bit differently. The Prosperity Economics way would be to choose a 30-year mortgage, and save the difference into a life insurance policy. That way, you can build your savings all along the way. And if you still wish to make overpayments, you can. Yet you don’t have to, giving you some flexibility no matter the economic climate.
Is it Good to Have a Mortgage?
As you may have gathered, we actually believe it’s good to have a mortgage. Of course owning a home “free and clear” is a good thing too, yet if the choice is between having a long mortgage or a short mortgage, we’d recommend the long mortgage.
As we mentioned, mortgages get better with inflation. So a $1,000 payment you make now is going to seem like far less in 30 years. In fact, many people realize that by the end of a mortgage term, it’s one of the lowest payments they have. The contract of a mortgage makes it so you’re locked in, and your payments don’t change. This is unlike most other payments, which tend to go up over time (utilities, phone bills, and more). The only other payment that truly works this way is your whole life insurance premium (which is part of why we love it).
Most people treat mortgages like a “necessary evil,” however we think there’s a lot to appreciate.
7 Reasons to Keep Your Mortgage
Homeownership is a worthwhile cause. It gives you the freedom to live how you wish to live, and a sense of responsibility for your home. However, many people attempt to pay off their mortgage faster to build equity, save interest cost, and cut ties with the bank. Here’s why we think there’s value in keeping your mortgage.
Reason #1: Equity is Unrelated to Value
Contrary to popular belief, the value of your home is completely unrelated to the equity. In fact, the value is probably going to increase whether you have a small mortgage or a large mortgage. In other words, the market is going to influence your home’s value whether you’ve got a brand new mortgage or your home is completely paid off. The lack of a mortgage doesn’t make your home a better investment, or somehow build your equity better.
Reason #2: It Costs $$$ Either Way
When you pay off your mortgage, you are NOT eliminating an interest cost, only an interest payment. By locking equity in your home and making greater payments on your mortgage, you lose the opportunity to save or invest those dollars. This costs you interest, yet many people are unaware of this cost because it doesn’t show up as a bill.
We refer to this as “opportunity cost.” Your opportunity cost is what you could have earned if you had used your dollars to invest or save at a profit instead of paying off low-interest, tax-deductible debt. (And yes, we actually think of this as “good” debt.)
Reason #3: It’s Potentially Your Largest Deduction
There are very few deductions left for the middle class. When you keep your mortgage, you’re actually preserving what may be one of your largest deductions. This helps shield some of your income from taxation, and at a reasonable cost.
It is only an advantage to have the deduction instead of a smaller mortgage IF you save or invest the dollars you could have used to pre-pay your mortgage. If you can invest in a side fund earning only the same low rate of return as your mortgage, the tax deduction actually makes a 30-year mortgage more efficient than a 15-year mortgage.
Reason #4: It’s Cheap Money
Nobody will lend you money to invest at a cheaper rate than what you can get for a home mortgage. Borrowing money against your home is properly utilizing your most valuable asset.
There is a difference between bad debt and good debt, and in many cases, mortgage debt is “good debt” when managed properly. There are many ways that a savvy investor can put a tax-deductible loan for 3.5% to work!
Reason #5: You’re Safer Because of It
Banks foreclose on homeowners with larger equity first because it is easy to turn those homes for a profit. A large mortgage means you are less likely to be foreclosed upon if you can’t make payments. Most likely (if you have kept your equity in a safe side fund) this will never be a problem for you.
It’s a good plan to grow your equity in a side fund. Even if your desire is to pay off your home fully, you’ll maintain more control by keeping the money you would have contributed to a mortgage elsewhere where it is under your control.
Yet until the side fund grows large enough to pay off your existing mortgage, you will be at risk. No matter how much equity you have—or don’t have—there’s nothing “safe” about not paying your mortgage! And as the 2009 mortgage crisis showed, plenty of homeowners with “underwater” homes with no equity lost them in foreclosure.
Reason #6: You Have Great Liquidity
Keeping your home equity in a safe side fund means you have access to liquid funds in the event of an emergency. It also means you can move quickly if an investment opportunity presents itself in a time-sensitive manner.
When you use your dollars to pay down your mortgage balance, your dollars are doing the only job they can do. Unfortunately, it can be difficult to access those dollars to use them to do anything ELSE now, because they are locked up and under someone else’s control. The emergency/opportunity fund that you create allows your dollars to be used for many jobs, making them far more efficient.
By keeping the dollars in a side fund, instead of having an opportunity COST, you’ve got OPPORTUNITIES.
Reason #7: You Still Build Equity
Even if your principal balance never declines, your home will (most likely) continue to rise in value. This means that you will continue to get all the benefits of your mortgage and live in your home regardless of whether you own it free and clear.
Instead of using extra dollars to pay off your home faster, use them to save and invest instead. You’ll have all the benefits of owning a home, plus all the benefits of having access to dollars for opportunities.
Are You Paying Off a Mortgage Early?
Are you making extra principle payments against your mortgage? If so… is there a better, higher use for those dollars?
If you’re still interested in paying off a mortgage early, that’s okay. It’s important to make the decision that works best for you. If you’re interested in taking a longer mortgage and saving the difference, we’d be happy to help. You’ve got some options for how you can do so that can help you benefit from home ownership AND have a flexible emergency/opportunity fund. If we can help, please feel free to schedule a meeting or email your questions to firstname.lastname@example.org.