Is it wise to start paying off your house early? 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 Be Paying Off Your House Early
Even after digging into all the numbers, I want to tell you upfront that I’m still a firm believer that you should start paying 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 uphill 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 start paying off your house early– 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…
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…
- And….$771,813 in 30 years…
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??
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?
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 Start Paying Off Your House Early: 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.
- 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 start paying 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, bartender, 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 insight 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 gurus 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 principal, 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.
Paying Off Your House Early or Settling 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
- 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 are lots of things 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 start paying off your house early? Are you a laser or a flashlight?
AUTHOR Derek Sall
Derek has a Bachelor's degree in Finance and a Master's in Business. As a finance manager in the corporate world, he regularly identified and solved problems at the C-suite level. Today, Derek isn't interested in helping big companies. Instead, he's helping individuals win financially--one email, one article, one person at a time.