Should I pay off my house?

Like most important question in life, there is not a clear black and white answer. There are some people that would argue there is a clear decision, but that opinion is so strong because at the root of it; it is about values. The first strong value camp can be called the “debt crusaders”, these are people who believe all debt is bad, and while mortgage debt in many cases is necessary for home ownership; should still be attacked fiercely and paid off early. The other end of the spectrum are the "money optimizers" these are those that have the deep value that even a small percentage of a "spread" between debt and investing should be maximized or optimized for any potential upside or gain; that to do anything different is wasteful and a loss of opportunity. If your identity lands squarely in either one of these camps, then it can feel like there is an obvious best option. And for you there might be, it would be hard for you to do anything different. Unfortunately, many of us live in the middle, and while we don’t love debt, we also want our money to grow and not be wasted. So what is the best answer for the rest of us?

Recently my husband and I were having dinner with our neighbors and got into a discussion about this, with an interesting twist. Our neighbors had shared they had paid off their mortgage, but it was before "they knew better" and now in retrospect they felt like maybe it wasn't the best financial decision. Since I tend to lean towards being debt free is an amazing goal, I was curious why they felt that way? The main reason was they had a low interest rate, and investing the extra payments instead could have made them money since the stock market has averaged a 10% gain over time. That got me thinking, my husband and I have been very focused on paying off our house, we too have a low interest rate, the difference is we are older than our neighbors so have less time before retirement, and that felt important. I started asking myself, when is it a good strategy to keep a mortgage and when is it a good strategy to aggressively pay it off? I didn't have to wait very long to ponder this further, the next day I was on YouTube and saw a new video from Erin Talks Money, "Should I Pay Off My Mortgage Early or Invest? Here's What the Data Says" She definitely had my attention! And for all the reasons I always love her YouTube channel, this video did not disappoint. She breaks down the data and also discusses the non-data information that makes this decision very nuanced. I'll break down some of it for you and if you want to go straight to the video, just go to YouTube and find Erin Talks Money and look for the video on whether to pay off the mortgage.

She starts out by saying:

“this question stirs up strong opinions, on the surface it looks like a math problem, but when you dig into it, it's not just math. It's risk, it's timing, it's control, and for many people, peace of mind. And when you combine all of those things, you don't just get different answers, you get very strong emotions."

This is one of the truest things I have ever heard! And it is applicable to all things personal finance. Even though she continues with data and breaking down when it is a good idea to pay down the mortgage and when it is not, the comment section was pretty heated siding strongly one way or the other, with none of the nuances she had shared in consideration. This is a topic many people feel very strongly about one way or the other. But what if you don't feel super strongly? What if you are like my neighbors and are doing one thing or the other and on further examination are not sure if it was the right answer? What should you do? What is really in your best interest?

So let me break it down as simply as possible with Erin's conclusions and supporting data. Let’s start with the dilemma, and why the decision is important. When you pay off your mortgage, you are getting a guaranteed return on your money that is the mortgage rate in interest savings. When you invest the money in the market instead, you are getting a potentially higher yet not guaranteed rate of return. The question then becomes when do you take the guaranteed return in interest savings versus the potential gain available in the market? She also adds you have to factor in "after taxes, risk, and over your time horizon." She notes that the experts have weighed in and that across Fidelity, Schwab and John Hancock, they break down data on whether to pay off your mortgage or not into three distinct zones. Let's address what each zone is and any nuances on that advice.

Number 1, is the "Keep the Mortgage Zone" aka maximize growth

An example of when keeping the mortgage makes sense and is the clear winner based on data alone, is when someone has a mortgage rate of 0% to about 4%. And remember, inflation works in your favor. Your payment stays the same, while with inflation, that dollar amount is getting less valuable, meaning your principal and interest payment gets cheaper over time. Later in the video she also talks about timing, if you are under 45, then your money has the chance to grow over the long term before retirement, making it more likely that your money will earn an average of 7 to 1o% over time, making the spread worth it.

Number 2, is the 'Gray Zone" aka can go either way

This zone makes the decision a little more nuanced. This would be a mortgage rate of around 4-6%. She explains that the math is less clear in this zone because taxes, market volatility and behavior matter a lot more. There is less margin for error which means the risk of keeping the mortgage might outweigh the upside side of the spread, or it might work out. So that is why this is so gray. Think a 5.5% mortgage with a 5.5-6% after tax return on investment. Risk versus guarantee starts to matter more. That guarantee interest savings of 5.5% when paying it off gets more attractive when the market gains are not guaranteed. But it is still not cut and dry, because if you are younger the market might still win out, it is just not guaranteed. You could decide either way based on what is most important to you but there might be a real cost with either decision. This is where a split might make the most sense. Say for example you have $1,000 extra per month to put towards the mortgage or invest. With putting $500 per month on each, you are still saving tens if not hundreds of thousands on interest and earning a similar amount or more over a 20 year plus period in the market.

Number 3, the "Pay the Mortgage Off Zone" aka protect the plan

When your mortgage rate is around 6% and higher, the advice flips to paying the mortgage off for the guaranteed 6% or more return. That is hard to beat, because a market return of the same amount is not equal. There are taxes, sequence of returns risks, and market volatility to factor in that make a guaranteed 6% return from interest saved much more attractive. So if a younger homeowner has a 6.5% or 7% interest rate and even though they have a lot of time to be in the market, a prudent decision would be to pay the mortgage off early, then pivot when it is paid off and invest your mortgage payment into the market. You can use what you were paying extra on the mortgage in investments or towards other financial goals.

More to Consider...

Interest rate is not the whole story. Like I mentioned earlier, Erin goes into more things to consider:

1. After Tax Real Returns
2. Risk
3. Time Horizon

I have already mentioned time horizon by factoring in age above. We will dig into that a little deeper. For more information on after tax real returns and risk, I recommend checking out her video mentioned in the second paragraph above. To sum up after tax real returns and risk concerns for the purpose of this post, having a lot of time before retirement does even out some of the concerns of both, while a shortage of time makes these factors more critical. I mentioned above the age under 45, that could be misleading because that is based on a traditional retirement age of 65 or older, so if you are planning an earlier retirement, it is important to be more specific. It refers to a minimum 20 year time horizon before retirement. Because keeping your mortgage can seem black and white with a low interest rate when you have 20 to 30 years of working years left, when your extra money has a long enough chance to grow and compound. That time horizon also puts you in the position to have your mortgage paid off before retirement, even without paying it off early. With say 10 to 15 years left of working years, even with a low interest rate, you might consider a mixed approach for example to reduce your pay-off date to happen before retirement, for example.

If you are 10 years before retirement or even 5 or less, this becomes a completely different conversation, especially if your mortgage would not be paid off in time for retirement. Now going into retirement with a mortgage isn't a deal breaker, many people do retire with a mortgage. But there is a trade-off, it will increase your fixed expenses and put a bigger drain on your portfolio, meaning your portfolio needs to be that much bigger to support you. Others might keep a mortgage because it will be paid off soon after retirement, reducing fixed costs in a short period of time. It is a complex decision that will depend on the size of your portfolio, any guaranteed income, and other expenses you may have. A shorter time horizon reduces your time in the market if you choose to invest instead and increases the concerns of after-tax real returns and risk, because you will be drawing off that money for an income much sooner. A short time horizon might turn a keep the mortgage, to a pay the mortgage off answer.

As for Me and My house?:

Time horizon was a big contributor in our decision on when and how to pay down our mortgage. And let’s be crystal clear: paying off high interest non-mortgage debt, having an emergency fund and investing 10-15% of your household income into tax advantaged retirement accounts should be achieved before there is any “extra” to contemplate what to do next with. Having a stable financial base puts you in the position of having the luxury of putting more on the mortgage or doing additional investments. So once we were in that position we wanted to pay off the mortgage, but after talking with our Financial Advisor, we tweaked it a little bit. While being debt free before retirement is an important value for us, we also want to make sure our retirement balances are as big as possible, and with only 5 years before retirement when we were making this decision; it felt like heavy. We had a low mortgage interest of 3.75%, a short time horizon, and felt behind on retirement savings. We decided to max out all tax advantaged retirement accounts including maxing the over 50 catch-up contribution limits, as well as our Health Savings Account (HSA), instead of staying with only the suggested 15% of income going into retirement accounts. Now having those contributions automated, we throw everything else we can afford at the mortgage aggressively. This means it will be paid off a few years before retirement. By doing both, we feel like we are preparing our financial life for retirement in the best way we have control over. We are reducing expenses in retirement and increasing our retirement balances. It is usually not possible to do everything that is a goal at once, so by paying down the mortgage and maxing out tax advantaged accounts, it also means we have decided to wait on contributing to a taxable brokerage account and to a gap savings for retirement until after the mortgage is paid off. This way we are optimizing tax advantaged investments, will have lower housing expenses in retirement, as well as we still have time to save for other priorities before we stop working.

It is still more than a math problem for your decision:

Like Erin says in the video, this is not just a math problem. Even with math, it can still be an emotionally charged decision. Remember, this can be an identity and values-based decision too. If you are someone who wants to maximize every dollar, every reward point, every percentage of gain, then regardless of the math; it might just feel right to keep the mortgage and invest. If you are someone who can't sleep at night with any level of debt, and are willing to sacrifice a little optimization of gain to be debt free and that gives you peace? Then you might choose to pay off the mortgage even if the interest rate is low. Don't let analysis paralyze you. You will win if you choose to do either path, invest more or pay off your mortgage, or a little of both. Whichever you choose, you will be farther ahead than you would be without doing extra towards anything. If you are in a place where you have an emergency fund and you are investing everything you can afford into your retirement up to 15%, and do not have any extra to pay down your mortgage or invest in a taxable brokerage, you are still doing a great job. Having a good life now is important as well. Sometimes it is just your season of life, and us older folks have had longer to grow our careers therefore our incomes. And even if we have kids, by the time we are closer to retirement, most are on their own. When you do have a little extra to advance your financial future, either on the mortgage or in the market, your future self will thank you no matter which decision you make.

Disclaimer: I am not a financial advisor, just a future retiree and retirement planning enthusiast. I recommend you seek your own professional advice and do your own research. I love sharing my husbands and my journey with you and am very happy you are here! It is through conversations and learning other people's journeys that got me motivated to get on the active path to planning for retirement. My greatest desire is that the stories I share help inspire you to do the same. Until next time, be well and dream big!