by Josh Hargrove, CFP
Many wonder whether or when they should pay off their mortgage early. It’s often the largest of all debt service payments you make, and the notion of having that monkey off your back is tempting. Yet mortgages typically have very low interest rates, and could be lower than what you could expect to get if you invested those extra funds rather than making extra mortgage payments. So what are you to do? I “consulted” with five popular sources for financial guidance to get the feel for the types of advice you’ll find online. I was surprised by what I found, but the general consensus is…there is no general consensus. Like every other financial decision, it depends…depends on several factors which I’ll address below.
To kick things off, I consulted the quintessential rule-of-thumb financial guru, Dave Ramsey. Given that one of his radio program’s favorite tag lines is “where the paid off mortgage is the status symbol of choice,” I was surprised to find that he actually isn’t in favor of rushing into paying off said mortgage early. Instead, Dave advocates the wise approach of ensuring that you are on track with your retirement savings first before making those additional mortgage payments. Putting these in reverse order will result in you “losing valuable time that you won’t be able to make up – even with increased contributions to your retirement accounts.”
Hal Bundrick, CERTIFIED FINANCIAL PLANNER™ Practitioner and contributor to the popular financial site, Nerd Wallet, agrees with Dave, particularly among younger families. The longer time horizon for younger families correlates with a higher risk tolerance with their investments, and therefore a higher expected rate of return that can significantly outpace the interest paid on the extant mortgage. Put another way, suppose your interest rate is 4%, but you expect to earn 6% or more on your investments over time. You’ll achieve a much higher net worth by investing your surplus rather than making additional payments.
However, he makes a different case for the older crowd. Hal explains that in his experience, people feel good entering retirement “without the burden of a monthly mortgage payment.” Retirees generally are not seeking aggressive growth with their investments, but rather rely on them for income, and that means lower investment returns. Once the kids are grown, all other debts are paid, and you’re safely on track with your savings goals, I concur with Hal that the next logical step would be aiming to eliminate the mortgage in advance of your retirement.
[retirees] feel good entering retirement 'without the burden of a monthly mortgage.'
The psychological, or “feel good,” aspect of financial planning cannot be overstated. I commonly reference this factor in conversations with clients, which is why Motley Fool contributor, Christy Bieber, especially caught my attention on this matter. Paying the mortgage off early, she argues, bolsters one’s peace of mind with regard to risk of foreclosure in a down economy. Furthermore, it can foster a greater motivation for getting and staying debt free. Bottom line, when you feel good about your finances, you tend to make better decisions with your money.
She goes on to suggest one additional advantage for paying off the mortgage early. While people often focus on the massive amount of interest paid on the home loan, Private Mortgage Insurance, or PMI, is yet another cost of maintaining the loan. PMI remains in effect until the mortgage balance falls below 80% of the home’s value. Therefore, she argues, get there as soon as possible with extra mortgage payments to eliminate this added cost.
Interestingly, of all the sources I read only one person supported paying off the mortgage ahead of investing for retirement. Economics professor Teresa Ghilarducci in a Forbes article adamantly argues for an aggressive repayment, going so far as to discourage the purchase of any home when the buyer “can’t afford to pay it off between five to ten years.” However, Ghilarducci’s case seems built more on preventing the mortgage industry from profiting off of you than what is actually in the individual’s best interest, and only briefly (and unclearly) contrasts the advantage of early repayment with retirement savings.
Of all these articles, the individual with whom I agreed the most is Natalie Campisi, a popular mortgage topics contributor for Bankrate. Initially, she posits the importance of having liquidity “in times of economic downturns and personal emergencies.” Putting your surplus cash flow to work in an investment keeps the cash available as opposed to sinking it into a home that is illiquid. She contrasts this by also suggesting that an individual’s financial habits are another factor that must be considered.
Natalie notes, “if someone tends to spend or has trouble keeping money in the bank, then that’s a behavior that’s not likely to change, so it’s important to plan around it.” In other words, if you’re going to end up spending what you’ve saved in an investment, then you might be better off putting your surplus toward the mortgage where you can’t cash it out to buy the newest iPhone or Lexus. So what’s the final verdict? Ultimately, Natalie advocates working with a financial planner to make decisions like these – someone who is familiar not only with your financial situation, but your psychology and habits as well, and I couldn’t agree more.
if you're going to end up spending what you've saved in an investment, then you might be better off putting your surplus toward the mortgage.
A good financial planner will know you and your situation, and his or her job is to guide you to make the best decisions. The planner will not only give the right advice, but also hold you accountable to implement the advice along the way, something you can’t get from a book, radio program, or internet article. As a general rule, I suggest people follow these steps with their surplus cash flow:
Eliminate consumer debt (high interest)
Establish an emergency fund (3-6 months expenses)
Get on pace for retirement
Eliminate other debt (lower interest)
Additional mortgage payments
Save for college
Of course, any grammar teacher will tell you that “general rules” come with all kinds of caveats and exceptions. The same is true here, and before making any final decision, consult with your financial advisor.
So there you have it. Five viewpoints sourced from popular sites for financial advice, plus mine thrown in for good measure. The conclusion is that paying off the mortgage faster is a great idea, so long as it’s done in proper order within your financial plan. You should consider the math, the risks, the psychology, and your habits when determining the best course. Better yet, hire a good planner to do it for you!