The Real Reason You Should Pay Off Your House (It’s Not Interest Rates)

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pay off your house earlyIs it wise to pay off your house? Most people would say, “no”… While I have always told you yes. But what are the reasons behind these answers? Does it actually make financial sense to pay the full term of a 15-year mortgage rather than trying to pay the debt off as quickly as possible?

The Real Reason You Should Pay Off Your House

Even after digging into all the numbers, I want to tell you up front that I’m still a firm believer that you should pay off your house early. It’s not as much of a slam-dunk as some hardcore traditionalists lead you to believe, but I still firmly believe it’s the best path to wealth.

Why am I bringing you this message like I’m fighting an up-hill battle?

It’s because I am.

The Interest Savings…It’s Not as Huge as it Sounds

You probably already know the main reason why most personal finance blogs tell you to pay off your house — because of the hundreds of thousands of dollars you’d otherwise be paying the bank in interest. Here’s how the scare tactic usually goes…

Borrow $240,000 to buy that $300,000 house and you’ll end up paying…

  • $387,000 for it on a 15-year loan plan, or even worse…
  • $508,000 on a 30 year loan plan!

Yikes! Talk about way overpaying for a property!

But are you really…?

Let’s take a look at the math…What will your $300,000 house be worth in 15 years…or in 30 years?

The Value of Your Home vs. Your Total Amount Paid

If you bought a house this year and it was valued at $300,000, how do you project what it will be worth decades from now?

There are basically two beliefs about home appreciation:

  • That your house will appreciate by 5-6% each year, or
  • That your home will rise along with the general inflation rate

Which is correct?

Most real estate agents are huge fans of citing the 5-6% growth a year (obviously). And it comes from the Census Bureau reports…so it should be pretty credible, right? Well, yes and no…

pay off your home early - average home sale prices

In the above table, you can see that the average home selling price in 1963 was $19,300 (must have been nice, right???;)), and more recently in 2017, the average price was $383,900. Sheesh! Quite a difference!

When you calculate the compound annual growth rate of these selling prices, sure enough, you get a rate of 5.7% a year.

BUT, the data is misleading. 

First of all, the comparison shouldn’t involve new home builds – it should instead evaluate the growth in value of existing homes. Unfortunately, this data is nearly impossible to acquire since housing markets differ dramatically from region to region, PLUS there really isn’t a credible source (even today) that shows the value of homes from year to year either.

Second, the above data isn’t comparing apples to apples. The homes in the 1960’s were roughly 1,200 square feet. The new builds today are more than twice the size of that, so they obviously cost more!

Upon estimating the actual growth of existing housing (rather than new home builds), and then adjusting for the home size and inflation, the value of housing has really only increased by 0.2%. In other words, the housing market has really just done a hair better than the general rate of inflation.

So long story short, the data from the Census Bureau is correct, but misused terribly. When estimating the future value of your home, the rate you should use is actually 3.22% (ie. the inflation rate the U.S. has experienced since 1913).

The Future Value of Your $300,000 House

Now that we’ve got the correct home inflation rate, we can estimate the value of a $300,000 house 15 years from now as well as 30 years from now.

  • The $300,000 home will likely be worth….$481,190 in 15 years…

pay off your house early

  • And….$771,813 in 30 years…

pay off your house early

So let’s sum it up quickly here (I’ve been too long-winded on this already…!)

House paid on the 15 year loan:

  • You paid: $387,000 in total
  • Likely house value: $481,000

House paid on the 30 year loan:

  • You paid: $508,000
  • Likely house value: $772,000

What Gives? I Thought Interest Was Bad!

Based on the above examples, even by using the low growth rate estimate of 3.2%, the houses will still be worth more after paying the current interest rates of 4.3% and 4.7%. This must be a calculation error, right??

Wrong.

Without diving too deeply here, it’s the difference between simple interest and compound interest.

  • Your home loan is basically a simple interest loan, which means that the interest is calculated on the remaining balance of the loan. So, as you continue to pay on your loan, the balance comes down and you end up paying fewer and fewer dollars in interest.
  • The growth of your home’s value is using compound interest – In other words, the value increase of 3.2% each year is always applied to the prior year, which is always a larger and larger number as the years go on…and therefore a larger increase occurs each year, resulting in an exponential growth of your home value.

In the end, compound interest wins and your home value will likely be far greater than the amount you pay for it in total – even after all those interest payments.

So what does this all have to do with my challenge to pay off your house early? 

Absolutely nothing.

In fact, it actually hurts my cause.

By borrowing money from the bank, you’re coming out hundreds of thousands of dollars ahead vs. if you would have done nothing with your money.

The Real Reason to Pay Off Your House: The Crazy Results of Intense Focus

So what’s left to say? Shouldn’t I just end the article right here and now and say, “Go get a loan on house and pay it off as slowly as possible while it appreciates in value?”

Ummm…nope. (I don’t often give up that easily ;)).

While taking out a loan on a house and paying it down according to the assigned 15 year or 30 year time frame isn’t necessarily stupid, it’s still not the best way to get wealthy.

pay off your house early - the american dream is still aliveThe best way to pay off your house is to:

  • First, get out of consumer debt, then
  • build up an emergency fund that covers 3-6 months’ worth of your expenses,
  • put 15% of your income toward your retirement each month, and then
  • get crazy and do everything in your power to pay off your house as quickly as possible.

The real reason to pay off your house early is because of the power of intense focus

Do you know what happens when you accept the notion that taking out a loan on your house is smart?

Pretty much nothing…

You go on with life as usual – your expenses don’t really change and neither does your income. You just make your house payment each month, check the box, and then you keep on going nowhere like a mouse in a wheel, thinking that you’re getting ahead. In reality though, you could be doing so much better in life.

When you get sick and tired of all your payments and you get that Rocky moment where all you want to do is rip your shirt off and scream at the top of your lungs because you just want so badly to get out of debt, THAT’s when things really start to happen. That’s the defining moment where your financial life is about to change!

So then what happens that’s so much better than paying off your house in 15 years? What could be better than a $481,000 home value?

When you’re committed to paying off your house and want nothing more than to get completely out of debt, you’ll…

  • cut your expenses down to nothing…
    • you’ll stop going out to eat,
    • call up your cable company, your cell phone provider, and your insurance broker, and haggle for the best rates – or you’ll just cancel some policies entirely,
    • buy a cheaper, smaller car and save on gas…and you’ll even hop on your bicycle to save even more money
  • start doing everything you can think of to increase your income…
    • be the best employee possible and get a kick-butt promotion
    • work nights and weekends as a server, bar tender, disk jockey, or maybe even pizza delivery
    • start your own side hustle cleaning houses, fixing cars, walking dogs, or maybe even starting your own blog
  • and you’ll load every spare dollar toward your home loan and watch its rapid decline

That’s what exactly I did.

Instead of paying my house off in the 11 years that were remaining on the note, I did it in one..That’s right, one year.

  • I cut my lifestyle by $15,000 a year,
  • I increased my income by $20,000,
  • And, my determination got me thinking of a variety of other ways to pay down the debt
    • like pushing to get reimbursed for my schooling from my company,
    • using insurance money from a claim to pay down my house rather than fix it (ha! I think I’m finally going to fix the damage this year…;)), and
    • selling everything in sight that was valuable and that I really didn’t need

So, by committing to pay my house off, I essentially earned myself $35,000 more a year than if I would have paid it off according to the schedule. THAT’s the power of intense focus and it’s the factor that most finance guru’s tend to ignore during their “proofs” and calculations.

Instead of using their estimate of being able to pay off your home only slightly early with your moderate excess, by applying an additional $35,000 a year toward the principle, you could be done with your loan in just 5 or 6 years!! At this point, yes you’d be able to save some money in interest, but the REAL benefit of paying your house off early is that you can now invest in something that pays a far better return than 3.2%. Start putting that money into an S&P Index fund and start earning 8% or more!

Where could you be financially if you paid off your house in 6 years, then invested your payment for the remaining 9 years?

  • If you do like I did and pay your house off early – let’s say you do it in six years – your house will still be worth $481,000 after 15 years, BUT
  • You’d have 9 years to invest your monthly house payments (that you no longer need) – roughly $1,700 a month
  • Drum roll…after 9 years of investing, you’d have another $275,000!!!

Instead of just owning a $481,000 house and nothing else, you’ll also have a $275,000 retirement fund after that 15 year stretch. BOOM! THIS is the story you’ll never hear from the financial gurus, but it’s absolutely true. I’m living proof of it after all.

pay off your house early - then invest

Pay Off Your House Early or Settle For Mediocrity

In this world, there are really just two ways to handle your finances. The method of the flashlight, and that of the laser…

Those of you that will just continue to pay off your mortgage as scheduled, you’re the flashlights of the world. You’re paying attention and you’re staying on top of everything, but your light is scattered over many things:

  • mortgage payments
  • consumer debt payments
  • entertainment
  • status symbols (clothing, accessories, going out to eat, giving lavish gifts)
  • choosing the right stocks – trying to beat the market
  • kids’ activities, etc. etc. etc.

There’s lots going on, you’re shining your flashlight all over the place to make sure all the plates stay spinning and everything gets paid, but you never seem to get ahead.

Now, what happens when you take sprawling light and you focus it into a thin condensed beam? You get a laser…A laser that’s so powerful it can cut through steel. All you warriors that have decided to tackle your house debt and focus on it above all else, you’re my lasers. By taking all your efforts and condensing them down into one sole purpose, your end results become exponentially greater than the results of your scattered activity. You’re the ones that will have $756,000 after 15 years…not just a $481,000 asset.

How about you? Will you pay off your house early? Are you a laser or a flashlight?

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24 comments to The Real Reason You Should Pay Off Your House (It’s Not Interest Rates)

  • My wife and I talked a lot about whether or not we should try to pay off our mortgage earlier. Ultimately we did, and for us the main reason was peace of mind. We’re a one-income family and being self-employed, my income is inconsistent. We felt having the mortgage taken care of would help us mentally and emotionally, and it has.

    • Yup – I’d agree with your reasoning all day long.

      My wife and I aren’t too dissimilar. She stays at home with the kiddos and I have my job at the office. We do, however, have a rental housee income, my blog income, and some photography business income. Still though…if I lost my day job, things would be really tight and extremely scary. We decided to slay the mortgage and have the peace of mind as well. It’s been absolutely AWESOME!

  • So many good reasons to pay off the mortgage. We’re chipping a away at it too! Soon and very soon!!

  • Paul Goode

    Hello again Derek, preaching to the choir. Haven’t had a mortgage for 25 years and retired early because of it.

    Paul

  • Julie

    I agree with paying off the mortgage early. I have a “What would Derek do” question for you-We paid off our house almost two years ago. Since then we put all our money(after retirement) towards a full renovation and hired decorators to make our house look beautiful. We wanted to do this ever since we bought the house but wanted to wait for it to be paid off before paying cash for the renovations.
    Now that all of that is behind us, what should we do with the money that used to be our mortgage payment? Our goal is buy a rental house in cash in the next two years. We plan on taking my husbands year end bonus and opening up a money market account for us to save to buy a rental house. Should we put what used to be our mortgage payment into that account to go towards a rental house or should we put the old mortgage payment into an index fund(like your example showed) to contribute to our retirement? Decisions decisions 🙂

    • Hi Julie – AWESOME question! And great job managing your money. We invest roughly 13% of our income into the stock market (mainly into Index funds). The rest, we save up in a money market account so that we can later pay cash for the next rental property. It won’t seem like your investing is gaining you much traction at first, but once you get past that first rental and have that additional income coming in, it’ll a snowball effect saving up for the next one!

  • Paul

    Hi Julie,
    I know you are waiting for a reply from Derek but I thought I would jump in because my wife and I had very similar situations as what you are trying to decide. We did the same thing with the house we live, really nice and just what we want. (Everything from here out is just my opinion or my personal experience. You may or may not agree with me, no problem. We decided to go down the “rental” route like you mentioned. We did really like the income it provided, the equity, tax advantages, etc. There just came a time years later we didn’t want to do it anymore. At that point we decided on mutual funds, both bonds and stocks with different approached to the holdings. (growth vs income, vs etc.) as well as an emergency fund that I am sure is larger than anyone would say we need (even you Derek 🙂 But what we like is just knowing we feel we have just about anything covered. the real unknown is your health and what that will cost. We have tried to save as much as we can to try and self insure but of course we won’t know if we succeeded until it is to late to do anything about it. I personally think you have done a great job thinking all the options through. Take care, Paul

  • I love the idea because it gives you freedom, plain and simple. You have freedom to do what you want with the cash that you would otherwise have paid every month. You have freedom to maybe take a chance on something like a new job or going out on your own, where you might otherwise not because of your monthly obligations.

    We’re not anywhere near the payoff point, but the opportunity for that freedom is definitely the motivation to chip away at it when we have some extra money.

    • Yup – our mortgage-free life has enabled us to buy a house for cash, flip it for a $27k profit, and now we’ve got a load of cash that we can use to upgrade our personal residence! Life is good when you’re mortgage free.

  • Cooper

    Another great article, Derek. I decided two weeks ago to pay off my mortgage and now I’m selling assets in order to do so. Yesterday I sent in $14,000 towards the mortgage and next month I will send in another nice chunk. If all goes according to plan I will own my house free and clear by the end of next year.

  • Paul

    Cooper, IMHO, great move!!

  • Sam Kwan

    Tough decision. Invest the money or payoff the house. If we paid off the house, it would give a lot of freedom. But, there’s also potential in investing the same amount in index funds. After 8-10 yrs, you take what you made in the market and payoff the house. That’s what we’ve been planning on doing. Had the mustachian forum chime in on this plan, and they gave some valid info on the opportunity cost to payoff the mortgage vs invest, and majority recommended to invest. Plus, mortgage payments don’t rise with inflation, so over the years, you don’t feel it as much. I hate debt, so it’s very hard for me not to want to pay off the loan.

    • Hi Sam. The thing that most people don’t factor in when talking about investing vs. paying off debt is the “AAARRRRRGGHGHHHHHHHH!!!!!!” factor (that was me screaming at the top of my lungs…angry at my debt, and I want to pay it off as soon as possible!!! Do you know what the “I want to invest” sound is? “Mmmmmmmm”…with a half-smirk. Not very emotional.

      I killed my $54,000 mortgage debt in less than one year. Would I ever have invested $54,000 in a single year? Not a chance.

      THAT’s the difference. I say invest some (up to 15% of your income), but focus mostly on paying off the house with PASSION!!!

    • Cooper

      Thank’s Sam. I went back and forth on this for months. I feel that there is no wrong answer but I’m 61 years old now and feel that my upcoming retirement would be better without a mortgage hanging over my head. My monthly expenses will be around $1,000 and I can retire anytime after the mortgage is gone. It just allows me more freedom this way.

  • JP

    We have had a mortgage and also not had one. Currently we do on our home. It hasn’t been an urgency, but with retirement coming up it would cut my annual outlays down so much not to have it! Previously there was some minor tax advantage, so I clung to that. My understanding now is that we won’t get any benefit from it at all given the higher standard deduction.

    I also like your theory about paying it down getting you all fired up, versus the passion of investing the money. The passion for you was probably greater when you could see the end within a year. I think those who owe more than $150K may have slightly more trouble finding that motivation or seeing the end game- but that isnt going to stop me.

    Thanks!

    • Love everything you just said, JP! Best of luck to you paying off your mortgage! Do it with passion and you’ll be amazed how quickly it goes away!

    • Cooper

      Yes, JP, having my mortgage paid off being within sight is highly motivating. Next summer, when the mortgage is finally paid off, I’ll be able to retire on my terms as I’ll be eligible for Social Security then.

      I plan on continuing working as I like my job but it is nice to know that I’ll be holding all of the cards for the first time in my life and not have to worry about the economy or being down-sized.

      Thank you for your comment and good luck on paying off your mortgage as soon as you can.

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