There is perhaps no more controversial financial planning advice than suggesting a mortgage is a good choice for growing wealth and maintaining a strong financial position.
It makes sense that the advice is controversial though because so many well-meaning people suggest that paying off your mortgage is the “right” thing to do. It also on the surface seems like the right thing to do.
As I write this, the rate for a 30-year mortgage is about 6.4%. That makes the monthly principal and interest payment about $2,500 for a $400,000 mortgage. Over the course of 30 years, if you didn’t refinance the debt or make any extra payments, you will pay about $500,000 in interest and $400,000 back in principal. Meaning you will pay more in interest than you borrowed in the first place!
That sounds awful.
Then you hear the stories of how good a feeling it would be to be mortgage free. You imagine having no mortgage, and thinking how you would be in a better financial position as you have one less bill to pay. You think about all the money that would be “saved” each month without that payment.
Let’s see how much better off we would be if we worked to pay down the loan. If you were to make an extra $1,000 principal payment each month, you could pay off the mortgage in a bit less than 15 years and save yourself about $280,000 in interest. Now, you have not only the $1,000 per month you were sending in extra, but you also have the payment of $2,500 back in your pocket as well. Sounds rather good, right?
Well, only if you don’t consider the alternative. Instead of paying an extra $1,000 per month, consider sticking that money into a balanced index fund. By doing that, you could expect on average to accumulate about $325,000 over those same 15 years[i]. That would be enough to not only pay off the remaining balance on your loan, but also have some money left over. Now you could pay off the loan, but why stop there? Just keep saving that money, and at the end of 30 years, your loan is paid off, and you could have accumulated on average nearly $1.3 million[ii].
But I know what you’re thinking… Why not pay off the loan, and then save the entire mortgage payment plus the extra?
There are two reasons. The first is that on average, you don’t accumulate as much money, only ending up with about $1.1 million[iii].
Second, you lose flexibility.
By putting all your extra cash into your mortgage each month, you lose the opportunity to use it if something comes up. Life has a way of laying bare the best plans.
This is the same reason I’m not a fan of 15-year loans. Sure, the interest rate may be a bit lower, but the payment is a lot higher. And while it may be ok today, what happens if you lose your job?
With a 30-year loan (and savings), you gain flexibility that would allow you to pay off your loan sooner if you wanted to, but you have flexibility in case things don’t work out the way you thought.
Next, let’s remember that inflation is your friend when it comes to your mortgage. That last $2,500 mortgage payment is going to feel like a lot less than your first payment. That is because with a 3% inflation rate, the value of that payment will drop by about 58% in real terms. In real terms, your last payment will feel like it is only about $1,100 instead of $2,500.
One other point. Let’s get rid of the notion that by eliminating your mortgage, you are going to eliminate your house payment and magically turn your biggest liability into an asset.
You aren’t. You will always have a payment to make on your home – no, it may not be a mortgage payment composed of principal and interest, but you still have the T & I to deal with – taxes and insurance (oh, and don’t forget the costs for maintenance and upkeep).
If you believe paying off your mortgage might still be the right idea, but aren’t sure, let’s get back to personal. Sit down with a financial professional who can look at your financial situation holistically and help determine what’s best for you. And if you don’t have someone you trust, I’d be happy to help.
Nothing presented in this piece should be considered investment advice.
The example returns presented are ONLY EXAMPLES and not actual investments. Past performance is not indicative of future returns.
Dollar cost averaging does not ensure a profit and does not protect against loss in declining markets. It involves continuous investing regardless of fluctuating price levels. Investors should consider their ability to continue investing through periods of fluctuating market conditions.
Do your own research and speak with a qualified licensed financial professional before making any investment decisions.
Investment advice offered through Stratos Wealth Advisors, LLC, a registered investment advisor. Stratos Wealth Advisors, LLC and Wozny Capital Advisors, LLC are separate entities.
[i] Assumes savings of $12,000 per year for 15 years with an average total return of 8% before taxes.
[ii] Assumes savings of $12,000 per year for 30 years with an average total return of 8% before taxes.
[iii] Assumes savings of $42,000 per year for 15 years with an average total return of 8% before taxes.