You just received a $100,000 inheritance (Woot woot!). You want to be smart with it…so buying a Ferrari is out of the question. But should you pay off your mortgage early? Or, should you put the money into the stock market to earn more interest over time?
This is the age-old question…
Should You Pay Off Your Mortgage Early?
Ask almost any financial advisor and they’ll tell you to put your money into the market…
Here’s their reasoning:
- You’re likely paying just 4% (or less) interest on your mortgage loan, and the market has historically earned 7-8%. Thus, it only makes sense to put your money in the stock market and earn more.
- The interest on your home is tax deductible, so it makes more sense to keep it and save money on taxes.
It sounds completely logical at first, and many people go along with their reasoning (including members of my own family!!), but I’m still not sold on the idea.
P.S. Keep in mind also that your advisor gets paid if you invest…and they get nothing if you pay down your mortgage, which gives them some added incentive to push the investment…
I’ve followed the Baby Steps for about six years now, and I’ve become an absolute die-hard fan.
Here they are, in order from top to bottom:
- Save up $1,000 for a mini-emergency fund
- Pay off your consumer debts (car, student loans, credit cards, etc.)
- Save up 3-6 months of expenses for your real emergency fund
- Invest 15% into your retirement
- Save for your kids’ college education
- Pay off your house
- Become wealthy and give
Note that if you’re on Steps 1, 2, or 3, you shouldn’t be investing OR paying your house off early. Before you even consider either option, you should be debt free except your home and have a fully-funded emergency fund.
Pay Off Your Mortgage Early? Absolutely.
If given the choice between investing extra money in the stock market (beyond the standard 15%) and paying off my mortgage, I’d choose paying off the mortgage every. single. time.
What’s my reasoning? I’ve got four irrefutable ones.
1) A Guaranteed Return
You know that 4% interest rate that you’ve got on your mortgage loan? If you pay off your mortgage early, you don’t ever have to pay it! Basically, it’s like locking in an investment for 4% that has absolutely no chance of going down…ever. If you pay off a $150,000, 30 year mortgage, that equates to over $100,000 in guaranteed “earnings”! (the other suckers end up paying $250,000 for a $150,000 house).
When you invest, you’re taking on the risk of losing money…which everyone fails to mention for some reason. Sure, you might earn 8%, but there might also be a downturn and you lose 20%. If that happens, I bet you’d start wishing that you paid down your house!
Oh, and as for the tax savings, it really doesn’t amount to much…especially in the later years of your loan. If you’re lucky, you save 0.5% with this incentive, which is hardly enough to keep me from being 100% debt free!
2) Increased Cash Flow
Are you sick of being cash poor all the time? With money going toward your bills, food, kids, and YOUR HOUSE, it’s pretty easy to feel strapped. But what if you didn’t have your house payment? What if, instead of having that $1,500 go to the bank every month, it went into your own pocket?
That would be pretty sweet, huh?
Well it’s absolutely possible. Pay off your mortgage early and your bank account will fill up faster than you ever thought possible! Plus, you’ll have options that you never even considered before.
Without a house payment, we decided to:
- have my wife stay at home with our daughter (which we absolutely LOVE)
- buy a nicer kid-hauler (our 2008 Toyota Sienna has been AWESOME!)
- go on more vacations (Sanibel Island, here we come!!)
- invest more heavily for our future (early retirement perhaps??)
Escaping from our mortgage payment each month has been nothing short of excellent. I can’t ever imagine going into debt over a house again.
3) Increased Peace of Mind
Our house is ours and nobody else’s. If we lose our job and find ourselves short on cash for a stretch of time, we don’t have to worry about the bank coming and taking our house away from us.
If you owe more than $1 (yes, that’s one dollar) on your home, then the bank has every right to take it from you. Their name is still on the deed.
Don’t think for a second that you’re invincible. Foreclosures happen to regular people every single day.
4) The Kick-butt Effect of Increased Focus
I’ve saved the best for last. This is the reason that disproves every single investment brainiac out there.
If you remember from earlier, advisors often state that the stock market averages 7-8% and your mortgage interest only costs you 4%, so ignoring the mortgage and investing in the market is the obvious answer…. yeah, I don’t think so.
First of all (as we’ve already mentioned), there’s risk in that 8%, but there’s also another element that intelligent people often forget to factor in:
It’s your emotions.
My Real-Life Example
When my wife (now ex-wife) left me in 2012, I wanted nothing more than to break all ties with her. I didn’t want to see her, I didn’t want to hear from her, and I certainly didn’t want to owe her any money!
This is when I waged war on debt. I paid her the decreed $21,000 in just six months, and then I paid off my $54,000 mortgage in under a year!
This is the power of emotion (in my case, anger).
If my financial advisor told me to invest $75,000 in two years, do you think I would have done it?
I would have told him he was nuts and that it was impossible. I never would have even tried.
How much would I have invested instead? If I were fairly aggressive, I maybe would have put $20,000 away.
So let’s have a look here:
- $20,000 * 8% = $1,600
- $75,000 * 4% = $3,000
BOOM! Thanks to the power of emotions, paying off debt can absolutely be more advantageous than investing in the stock market!
It’s Your Turn
I write about this stuff all the time, and I can affirm the fact that being out of debt is an incredible place to be, but I can’t get out of debt for you. This decision and action has to come from you.
So what do you say? Are you going to pay off your mortgage early?
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.