Should You Pay Off Your Mortgage Early?

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:

  1. 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.
  2. 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…

pay off your mortgage earlyDon’t Forget About The Baby Steps

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:

  1. Save up $1,000 for a mini-emergency fund
  2. Pay off your consumer debts (car, student loans, credit cards, etc.)
  3. Save up 3-6 months of expenses for your real emergency fund
  4. Invest 15% into your retirement
  5. Save for your kids’ college education
  6. Pay off your house
  7. 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?

Absolutely not. 

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?

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46 comments to Should You Pay Off Your Mortgage Early?

  • whiskey

    Amen brother!! I can get behind all of it.

    So Ill ask a question: If you still owe $$ on your home but are planning to sell and move, would you still try to pay it off, pay as much as possible or invest?
    The timeline would be an obvious factor so how long, 1yr, 2 yr?
    What about the amount owed still vs timeline? 40k, 80k more? Or would you base it more on the monthly pmt?

    • Hi Whiskey. Great questions!

      1) If you owe $$ on your home, but plan to move, I would still work on paying it off – mainly because I would recommend you do the same thing in the next house, and this way you’re building up the equity, which will be transferred to the new house! The idea is to own a home that’s free and clear of all loans.

      2) Regardless of timelines and amounts owed, I would still recommend investing 15% of your income and then dumping all the rest of your money toward the mortgage. Complete debt freedom is amazing and I recommend that everyone give it a try! Heck, if you hate it, you can always buy a bigger mansion and take on debt again (but I seriously doubt you will)! 😉

  • Hmm, can I take option C and put a large chunk to the mortgage and invest the rest? I really like the idea of paying off the mortgage for peace of mind, but the appeal of investing a large chunk while still in my late 20s has me hooked…

    • I’d be okay with putting 15% of your chuck toward investments, but the majority should go toward the mortgage. In addition to the pros I mentioned in the article, there are some serious savings if you pay off your existing home and then buy the next one with cash (minimal closing costs, a discounted price because it’s cash, a quicker move-in date, no bank wrangling…). The list goes on and on.

      Pay off your consumer debts, save up an emergency fund, invest 15% of your income, pay off your house, and then get extremely wealthy. It’s as simple as that!

  • 2 years ago, I wrote an article, Retired, With Mortgage (http://www.joetaxpayer.com/retired-with-mortgage/), in which I described the numbers looking backwards over the prior 15 years. As of Dec, 2014, instead of a paid mortgage, we owed $233K, but had an extra $453 in our 401(k). This assumed the 401(k) deposits were already above the matching amount. Happy with the results then, and in the 2 years the market’s been positive since.

    We’re back to the “debt is evil” realm, and the assumption that most people are not good custodians of their own wealth. The David’s advice has a time and place. When my mortgage was 13.5%, paying it off was a priority. When I got married in ’94 and built the family house in ’96, 7.625% was also prime for prepaying. A sure 7.625% return on prepayments vs hoping for 8-10% market average? The prepay wins. But, the last refi, down to 3.5% changed the math. As did the early retirement.

    By the way, if we got an inheritance, which is a possibility, the money will be used to convert from traditional IRA funds to Roth. At a steady pace, and keeping us at the top of the 15% bracket each year.

    • Hi Joe. Great comment. I’m definitely not against investing while paying off the mortgage, but for most, I think they’d rather see that mortgage payment go away sooner than 30 years (or 40…or 50…)! Even at a 3% interest rate, the method still holds true for me. Invest 15% of your income to your retirement (which should accumulate to $1M+ if you start relatively early), and then put the rest toward the mortgage. Simple, effective, and a relief when it’s gone!

  • Dani

    I absolutely agree that it’s a much more of an emotional pull to pay off debt–even if it’s not due to an ex–than it is to ACTIVELY save. Lifestyle creep happens even when you don’t get a raise but no longer owe a creditor a monthly payment–and it’s just as detrimental. When I look back at what hubby and I were making 8 years ago, it’s only a little bit more than we’re making now; however, our mortgage was higher, we had several credit cards, a negative cash-flowing rental property, and kids living at home still. So why is it so hard now for us to invest what should feel like a flush of cash, why was it so much more motivating to pay down than it is to built up? Against ALL wisdom, my “how stupid could it be” thought is to borrow money and invest it, because 1) then it will be invested, and 2) I’ll be motivated to pay off the loan.
    Don’t worry, I’m not going to do that, but it does cause one to wonder at the power of getting to zero as a motivator!

    • Hi Dani. Sounds like you need to re-evaluate your “why”. A goal to get out of debt is much more motivating than saving up for no purpose whatsoever.

      So what is it that you want to do with your life? Do you want to retire early? Travel the world? Give massive amounts of money away to a charity that’s close to your heart? Once you figure out your why, you can work backwards to see what it will take to get there. THEN you’ll be more motivated to save.

      For Liz and I, we know that we want to put 2 kids through private schooling, which basically means that we need to own two rental houses free and clear that will supplement this goal! So, we’ve got one, now we’ve almost saved up enough for a second. Then, our next goal is to live in a home on some acreage, so then we’ll save up money for that! It’s definitely the best way to stay motivated to save. 🙂

      Hope this helps!

  • I’m paying off about $20k of my mortgage this year to get rid of PMI. After getting rid of my PMI, I’m going to let it hang out until my 5/1 ARM gets to the 5 year mark. I’m at 2.625% on my interest rate, and when you consider the tax deduction, it’s more like 2%…. super low. PMI though is a decent amount, so getting rid of this will be good.

    I also agree with you on investing. I figure if I’m not forcing myself to invest or pay down debt via automated savings then I just let it sit in cash.

    • Erik – I would check with the lender. My understanding is that a loan that’s paid on the regular amortization schedule will have the PMI removed once you hit 78% LTV. But if you reach that via pre-payments, it’s not automatic, and the lender might insist on a new appraisal. On one hand, I’d be happy to be mistaken, that the PMI comes off with no fight. But either way, you should ask, and avoid any surprises. PMI creates a range of balance on your mortgage where those last dollars actually cost you a huge rate. Third only to matched 401(k) deposits, and credit card debt, this is the smartest debt to kill, the portion that forces PMI.

    • Hi Erik. If I were you, I’d be nervous about having an ARM for a mortgage. At this point, you have absolutely no idea what your interest rate will be in that fifth year. It could be that it’s 6%+ by then! I’d at the very least be saving up money to chunk at the loan if that happened.

      Sometimes you seem a bit too non-nonchalant about your debt!

  • Emily

    So in the area of the country I live in, home prices are much higher than your situation. We own a townhome, our purchase price on our home for $400k. And we livein the cheaper area. We own less than that. But it makes me ask the question. What percent of your monthly income were you throwing at your mortage to pay it off? Also, what other thoughts you might have on the subject matter when people live in such places.

    • When I was paying off my mortgage, I was probably putting 50%-60% of my take home pay at the loan each month. I had a goal and I was GOING TO HIT IT!!

      For those that live in areas where housing costs are super high, they just simply have to be more diligent about living on very little, earning as much as they can, and saving up a huge down-payment.

      Here’s my rule of thumb for everyone:
      – live in the cheapest (but safe) rental you can find. Share it with friends to keep costs super low
      – save up a 20% down-payment for your house
      – purchase a home on a 15-year mortgage and make sure that the payment is no more than 25% of your take-home pay each month
      – if the 25% rule isn’t possible, you either need to 1) save up a bigger down-payment, 2) buy a cheaper house, or 3) figure out how to earn more money.

      It’s definitely not easy to live in a high-cost area, but it’s certainly not impossible! Best of luck to you Emily!

  • Hi Derek,
    Great advice on paying off the mortgage early, unless of course the rate is super low like 3%. We could easily payoff our $100K mortgage right now if we wanted, but that is the cash we’ve accumulated over the last 3 years and 4 house flips that we will be reinvesting into the next house flip project.
    We typically make 1-2 extra house payments per year and a lot more goes towards principal than interest. We used to make a half payment every 14 days but our bank quit doing that program.
    We can get about a 20-30% return on our house flipping business, isn’t that better than the quoted 8% in the market? I think so, as long as the house market stays hot. Eventually it has to take a dive, then it will be a great time to get a DEAL on another project house with cash. Just have to hold it until the market comes back up.

    Keep up the good work, I look forward to your weekly articles!

    • Hi VH Homes. I teach people to invest 15% of their income and then put the rest toward their mortgage. After the mortgage is gone, they could easily bump up their investing since they’d have absolutely NO HOUSE PAYMENT!

      It sounds like you’re flipping houses with cash. What if you kept 15% of the profits and put 85% into your home mortgage after the next flip? That way you could keep flipping and earning money, but also have your house paid off in just a couple of years.

  • Joshua

    As someone who spent a year and half paying down almost $70k in student loan debt, I couldn’t be more in disagreement with this. If I can obtain average returns in the 8-10% per year range while my debt only costs me 3%, the best fiscal choice is to take every free dollar and invest it in long term assets. Don’t get me wrong, it’s great being debt free. However, had I continued just paying the minimum towards my incredibly cheap debt and investing spare dollars, after 10 years my net worth would be approx. $20k higher. Interest rates are at all time lows and this article significantly undervalues the benefit of very cheap capital. I totally get the emotional fire of paying down debt, but I’d much rather still have my debt right now if it would bump up my net worth.

    • I didn’t hear anything about risk in your statement. Investing is not a sure deal. Paying off debt is.

      • Joshua

        I’m not sure I understand your point. Are you advising people that the best way to financial freedom is to take as little risk as possible? My point was that if you can get returns in excess of your cost of capital then you should do that. Yes, risk appetite does factor in but it’s not the major take away here. It’s not unimaginable that in 5 years interest rates will rise high enough where 5% returns can be obtained at little to no risk. If someone has a 30 year mortgage at 3%, they should absolutely invest in that 5% bond instead of pay down their debt. In today’s market, for someone in their 20s, the risks associated with the stock market are well worth the potential returns. The blanket statement that everyone should always pay down debt over investing for the future is simply incorrect.

        • For the most part, I just hate how clear cut everyone makes it sound. A house costs just 4%, investments typically earn 8%, therefore you should invest instead of pay off debt.

          Not true.

          There’s risk in the investment, plus by emotionally tackling your debt, you can often pay off far more debt than you can invest in the market.

          It’s just not as clear cut as most people think it is. I paid off $54k in a year, and now I invest heavily in the market and real estate. I wouldn’t have it any other way.

          • Joshua

            I assumed 8% was a relatively conservative rate of return to use in my example as that’s the assumed rate of return you used in your retirement savings by age article. It seems inconsistent to assume someone can obtain 8% a year in that article but insinuate that it’s more risk than someone should take in this article. I will agree on one thing though. If someone feels they will be significantly less diligent with investing than they will with paying down debt, they should definitely pay down debt, as doing something is better than nothing.

          • Hi Joshua. Yes, I believe that someone can earn 8% in the market, but is it more risky than paying off debt? Absolutely! And, there’s risk in keeping debt too (potential foreclosure). This is why I recommend that people invest 15% of their income and then pour everything else on their mortgage. If they can do both, they’ll be more wealthy than 99% of the U.S.!

  • Paul

    About 25-30 years ago I paid off my mortgage at the time. After living that life for a while I decided to never go back. I have moved many times in the last 30 years but now I only buy house in total cash. I could never have a mortgage again, it would haunt me!

  • Natphoru

    I disagree with several of your points.

    #1 – you briefly touched on taxes, but then didn’t consider it in your guaranteed return. You also did not consider inflation in your guaranteed return. While you certainly should not carry a mortgage for tax deductions, if you already have it, you should calculate that into your return. A 4% interest rate may be as low as 2.42% tax adjusted (in the top marginal tax bracket) or more likely 3-3.4% if you’re in the 25% or 15% brackets, respectively. We must further adjust for inflation (currently .5%). In a 33% marginal tax bracket, my inflation and tax adjusted mortgage interest rate starting at 4% is actually 2.14%. That guaranteed return is starting to look pretty bad.

    #3 – I argue that you will actually have decreased peace of mind. If you make an extra payment on your mortgage and suddenly lose your job, your bank won’t let you skip payments. On the other hand, if you put money into a liquid investment such as stocks and you lose your job, it’s relatively straightforward to pull the cash back out. If you have a job loss, even if you have 6 months worth of expenses saved, which position would offer greater peace of mind – 6 months of emergency fund + the ability to liquidate investments as an extended emergency blanket if needed, or 6 months of emergency fund and the knowledge that you’ll need to start trying to sell your house in 3 months because you opted to put $20k extra into a 2% return over the last two years rather than something more liquid?

    My biggest problem with this strategy is that it teaches debt is bad. Debt is a tool. It is neither good nor bad. Debt has some pretty stupid uses, like high interest loans on consumer goods that border on worthless or primary homes that produce no income and are assets on someone else’s books – not yours. Debt has some amazing uses, like leveraging $100k worth of cash flowing assets with only $20k of cash.

    My second biggest problem with the pay down the house quickly strategy is that it teaches investing through emotion rather than looking at the numbers and investing rationally. You even state this – “BOOM! Thanks to the power of emotions…” Emotion should not be used to gauge an investment.

    • Joshua

      Absolutely agree with this. Well said.

    • Hi Natphoru. I appreciate the comments (even though you don’t agree with me).

      #1) It’s still a guaranteed return, no matter how you slice it. And factoring in the emotion of how quickly you could pay it off, you’ll probably still win over investing moderately (you failed to acknowledge that point).

      #3) When I was paying down my mortgage, I had $15k stashed away. It took me only 1 year to pay off $54k. Now I’m debt free and have a complete peace of mind. Oh, and now I’m stashing away $3,700 a month toward out investments. There’s no way I could have done that with a mortgage.

      For a corporation, sure, I can understand taking on some debt. But for individual people…I don’t think so. Debt is not a tool. It’s idiotic, and it’s only setting you up for a crash later in life.

  • Yup, we’re also paying off our mortgage early. More than anything it’s so we can have more peace of mind during retirement. If the economy goes belly-up, at least we have a house that’s paid for!

    • Yup! I can’t imagine having a mortgage in retirement! What a buzz kill!

      • Ben Hackney

        You will always have property taxes, home insurance, and potentially an HOA. Even if you completely pay off your mortgage. When you discuss sending $1500 to the bank every month and having that much extra money… don’t forget that you will still be sending off money at least once a year in large chunks to pay for home insurance and property taxes. You talk about there being risks in investing which is absolutely true BUT you seem to ignore the fact that as long as you stay invested in a low cost index fund for 10+ years there has never been less than a gain of less than 7%.

        • History shows that you’ll likely have a return by investing, yes, but you’re forgetting the emotional piece again.

          Let say you’re set on investing instead of paying off your mortgage, and then the stock market loses 25%. And then it loses 10% the next year, and 5% the next year.

          You Ben (a wise investor), might keep buying. Heck you might even buy more aggressively because all the sticks are on sale! But, what would most people do? Either they stop investing, or worse, they cash out…because of their emotions.

          Why do people fight me so much on this? Invest 15% of your income and use the rest of your free cash to pay down the mortgage. You’ll get the best of both worlds!!

          • Ben Hackney

            I’m challenging you because 15% is tiny when your savings rate is 50+%. Also is your audience not mostly people like me who are seeking FI and are “wise” investors?

          • If I invest 15% of my income for the next 35 years, I’ll have $2 million — which is plenty to live off of. Anything more than that is just icing on the cake. So, when the mortgage is paid off (typically in 5 years or less), you’re in a position to become EXTREMELY wealthy. 🙂

        • Ben – In general, I agree with you. Your last sentence is incorrect. The S&P, ignoring fees, had a negative return over the 2001-2010 decade.
          If you are disciplined, and have nerves of steel, go with your plan. I did just that, and even through the down years, came out far ahead by staying invested. But, to Derek’s point, it’s not a sure thing. This is why there are phrases like “risk tolerance” and the question “What do you do if the market drops 35%” Too many people sell at the bottom. Which is why the average investor see far lower returns over their lifetime than the indexes would have you think.

          • Love the add here JoeTaxpayer. Thanks for always telling it how it is!

          • Ben Hackney

            JoeTaxpayer valid point on the 10 year period from 2000-2010. I should have said no 12 year period and I think I would have been safe with my statement. I suppose I often forget people don’t have nerves of steel, and they haven’t needed them for almost 8 years now as the market has done almost nothing but go up up up! How short our memories are 🙂

            Derek – what if I don’t want to work for the next 35 years? Perhaps this audience is more geared to working until 60 and retiring in which case your advice would be stellar.

          • Honestly, is still recommend the same plan. I will probably retire extremely early, so with no mortgage payment I can invest heavily into both my 401k and real estate. The real estate will be my main source of income and I’ll just let the 401k grow until I’m 60 (which will still be $1.5M or more, even with the reduced contributions) Boom, boom, done. All with no stress.

  • Paul

    Natphoru, This is a really like a love/hate relationship. There are individuals who firmly believe in your idea and others believe in paying it off. I firmly believe the 2 things that helped me the most in getting ahead in life/finances was the lack of mortgage and moving to Nevada with no state taxes. (An immediate raise of almost 10% at the time) As my income grew with no state tax and no mortgage it was amazing the amount of money left over to invest. Using this money to invest helped me to retire early.

    • Yup, I’m with you Paul! Having absolutely no payments is an amazing feeling and has really propelled my wife and I financially. She’s a stay at home mom and we’re still killing it! It’s awesome!

  • Interesting point. I have been working on paying more on my mortgage.

  • Jay

    What about taking the windfall and paying off a rental property so that the cash flow essentially pays the 3% Primary home mortgage payment? Isn’t that kinda’ like paying two homes off at once?

    As for making additional payments on a mortgage with a low interest rate – I believe the much safer move is to save up enough to pay the entire mortgage off and then pay it off all at once – if one decides that they want to feel good.

    Thoughts?

    Thanks for the post!

    • Can the rental property be paid off fairly quickly (2 years or less)? If not, then I recommend selling it and taking the equity to pay down your primary residence. Once your house is paid off, start chucking money into an account to buy a rental with cash. You’ll have far less headaches and variability in your expenses from month to month. By ditching the rental, you’ll be able to focus on that one thing…the mortgage, and pay it off insanely fast.

      I don’t think it’s necessary to put the money aside until you can pay off the mortgage. In fact, you don’t get as much of a high doing that as you would if you saw the mortgage going down and down and down. If you lose your job, just live on your emergency fund. That’s what it’s there for.

  • Hi Derek,

    Thank you for writing about this controversial topic.
    I would be interested to have your opinion on our situation : living in Switzerland, 550k mortgage at 1.65%, debt decreases our taxes.

  • Jay

    To clarify – the windfall would be enough to pay off the rental property immedialty, but not enough to pay off the primary property.

    Why not use the cash flow from the paid off rental to take care of the monthly payment on the primary?

    Kill 2 birds with 1 stone?

    • I’m not totally opposed to the idea (especially if you’re going to start chucking away at the home mortgage to get it paid off), but I’d hate to see something happen where your primary home is at risk of foreclosure.

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