I’m in the midst of a home refinance, and, let me tell you, this is seemingly the home refinance that never ends. I actually first put my application in during the month of November. However, I promptly went to Hawaii and did not return the loan company’s initial acceptance letter until I returned. The loan company then promptly kept stalling when they realized just how much money they would lose by refinancing my mortgage. Let’s just say that between now and 2021 (when my mortgage will be paid off 15 years early) the mortgage company will only make a total of about $5,000 off of me. So delay after delay after delay have occurred. We are finally closing in on the closing date.
In the meanwhile, I received a question from a regular reader about “if” and “how” to pay off a mortgage early. I now feel well equipped to answer this question. I thought there would be no better way to answer the question than here on this blog as a wider conversation.
But Before I Get to That…
First things first, I want to point out that, where mortgages are concerned, it is my fundamental belief that we enter into far too many of them over the course of a lifetime. As I pointed out in “How Much Does Good Credit Save You Over a Lifetime?” the belief that we derive some sort of profit from a property simply by selling it again at above our original sale price is a fallacy. For the average $188,900 home, you will pay a total of $363,980.35 to $385,308.96 (depending on your credit) after making 30 years of mortgage payments. You need to look at the total amount of money you have put into the property to date (including principal, interest paid, transaction/closing costs and agent commissions) in order to truly assess how much money you will make (or lose) from the sale of a property.
Another reason that I don’t like the number of primary residence mortgages the average person takes on over a lifetime has to do with retirement savings. As shown in “How to Retire Early by Balancing the Invest vs. Spend Equation” the total amount of money you need at retirement decreases significantly if you can also bring down your monthly cost of living. Completing the term of a mortgage is one of the most effective ways to bring down your monthly budget. As such, the number of new mortgages you enter effectively increases the amount of time you will need to spend working (as opposed to retiring) because you have elongated the timespan within your lifetime that you will be living with a mortgage.
As such, it is best that before you take on a commitment as large as a mortgage that you consider the purchase from a long-term perspective. Is this a home that will evolve with you over time? Ask yourself:
- Can you afford this home now and in the future?
- Can you raise your children in this home?
- Can you maintain this home into retirement?
Take your time. Do your research. Do not feel pressured into making a decision right this very second on an investment that will take you the next 30 years to pay off. An investment in a home is certainly one that you do not want to make out of impulse.
Okay, now that this is out of the way…
Most posts on the topic of “if” you should pay your mortgage off early start by saying that there is no black and white answer for everyone and the answer depends on a variety of variables, and blah blah blah, and blah.
This is not one of those posts.
I’m going to be pretty clear on a couple of points. Here is the first one. You have heard me say before that if you cannot pay a car off in three years, then you cannot afford it. Likewise, if you cannot pay a house off in 15 years, then I believe that you cannot afford it. I’ve read other bloggers state that 30 year mortgages are better because they give you both the flexibility to pay them off in 15 years (if you choose) or the leniency to pay a lower payment if you need to for whatever reason. However, given what we learned in “How Much Does Good Credit Save You Over a Lifetime?” interest rate is everything, and interest rates decrease for mortgages of shorter loan duration. Let’s use my mortgage as an example. My original mortgage was roughly $70,000 with a 6% interest rate (closed in 2007). All told that would have cost me $151,086.73 after making payments for 30 years. However, I am paying it off in 15 years and with a lower 3% interest rate because of both the shorter loan duration and changes in the market interest rate. At the end of 15 years my home will have cost me a total of $85,812.18. Let’s think about that. I will pay $65,274.55 less for the very same home all because I paid my mortgage off in 15 years instead of 30.
The second factor in the “if” comes down to the investment priority list. Let’s say you are already paying a 15 year mortgage and you want to know if you should pay it off even more quickly. This is where it does depend, but it depends upon something very concrete and easy to identify. It depends on where you are in the investment priority list. I’ll restate them here:
- Phase 1 – 401(k) Bare Minimum to Company Match
- Phase 2 – Pay off High Interest Debt
- Phase 3 – Create an Emergency Fund
- Phase 4 – Go “All In” on your Roth IRA ($5,500 per year) and your 401(k) ($18,000)
- Phase 5 – Consider Paying Off Some Low Interest Loans
- Phase 6 – Taxable Investments
If you have already completed phases 1 – 4 in the investment priority list, then, yeah, you might want to consider how much more you could save by paying your mortgage off even more quickly. If you have not done Phases 1-4, then you should start there first because you would effectively make more money by investing your extra dollars differently. You can see all of the calculations supporting this reasoning in “Money Doesn’t Grow on Trees. Find Out Where it Does Grow.“.
Last things last, I think everyone should work to pay off their mortgage before they retire (as I mentioned above). By understanding the “retire to infinity” lessons in “How to Retire Early by Balancing the Invest vs. Spend Equation“, along with the present value formulas in the time value of money post, you can accurately predict not only how much you will need to retire but also how much should be in your accounts now in order to retire with the funds that you planned. In that way, using your extra dollars to pay off your mortgage more quickly versus using that money to invest for retirement is not just a simple interest rate comparison. By paying off your mortgage you are reducing the amount of money you have to invest in retirement in the first place. Sometimes substantially.
Now we get to the “how” part of the question. Much of this has been answered for us in the “if” section, but here we go in order:
- Pay off your mortgage in 15 years instead of 30
- Refinance to a lower interest rate if you stand to save more in interest payments than you would in refinance closing costs
- Remember that both paying off debt and investing are both “investing”. By paying off debt you are earning money by not having to pay it to lenders in the first place.
- Pay close attention to the investment priority list to make sure you are getting the most out of all of those extra dollars you have left to invest.
- Once paying off low interest debt is the best alternative for your investments (Phase 5 or higher) then allocate a portion of your budget towards the principal of your mortgage.
- Send any and all extra mortgage payments with the words “towards loan principal only” as a memo attached to the payment.
There you have it. Have any other money questions? Be sure to comment below or contact me via social media if you do.