It has been a year since we paid off our mortgage early. I already discussed our reasons for doing so in that post, so I won’t repeat them here. I also wrote a really long post on every single facet I could think of in the Pay Off Mortgage Early vs. Save More For Retirement debate. So I won’t go into that here either.
But how do we feel a year later? Did we regret it? Let’s take a look at what happened from March 2013 to March 2014.
Mortgage rates bounced around a bit but in general look to be about half a percentage point across the board. (Source: HSH.com) I probably couldn’t get the same mortgage rate I had before anymore, but it would still be a pretty low rate historically.
Investment returns over the last year were quite robust. If I model my portfolio roughly with the Vanguard LifeStrategy Growth Fund (VASGX) which is a low-cost index fund split roughly into 80% broadly diversified stocks and 20% broadly diversified bonds, my trailing 1-year return would be 15%.
Bond interest rates in particular went up overall. The 10-year Treasury Bond rate went from 1.8% to nearly 2.8% over the last 12 months. (Source: FRED)
(Note I don’t talk about the value of my home. This is because paying extra towards your mortgage early is not an additional investment in your house. You already own the house so you are already exposed to any change in home value regardless of your mortgage size. The mortgage is just another debt with an interest rate.)
So interest rates went up and we could have earned more money investing the money in my portfolio rather than pay down my 3% mortgage. Well, if I had a time machine maybe that would matter. But in reality it has been great. The lack of a mortgage reduced our monthly expenses significantly. We have been able to work less and got to spend an entire year watching our colicky baby grow into walking, talking, little person (meaning we are still more tired than ever before, ha) while still maintaining good cashflow and thus minimal financial stress. I’m not saying this applies to anyone else, but paying off our mortgage early has worked out well for us.
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Yeah. Not having that monthly expense probably balances things out.
Now, about the baby. My wife went to visit her parents and took the our baby with her. It’s kinda weird and a bit depressing to return to an empty home. BUT! I’m getting an awesome sleep!! 😀
Best sleep I’ve had in almost 2 years. I have about a month to enjoy this. *grin*
By coincidence, my wife is taking the kiddo on her own for 3 days next week. This will be the first time I’ll be separated from both of them since her birth. I’m totally with you… it will be the first time in 19 months that I will be able to sleep in and wake up on my own!
This seems like another good example of why the decision to pay off one’s mortgage is emotional rather than logical. It would make sense, logically and mathematically, to say “I regret paying off my 3% loan instead of investing at 15%”. Yet you have no regrets. I am in the same boat as I’ve been aggressively paying down our low interest mortgage too. I’m fine since emotionally it’s what I want for our family – zero debt – so that’s all that really matters to me.
The thesis you’re presenting isn’t very clear-first you demonstrate mathematically that it would have been far better to have kept the mortgage through last year, then you rationalize and say that it all doesn’t matter. Why were you able to work less just because you paid off the mortgage? You could have taken the cash flow out of your investments instead, and paid yourself from it, thus keeping up high cashflow AND better returns. You would also have had a bigger cushion in case of financial need, so it’s not clear how this reduced stress.
BTW: I don’t think your base argument is wrong-I paid for my house in cash as well-but the financial argument should be as follows:
Statistically, not every year is like last year. A 1-year look-back is irrelevant. Imagine if you had run this analysis in 2008! If you have a mixed portfolio, (bonds+stocks), count on no more than 8% returns. After taxes, that’s 5%. A mortgage costs approx 4%. Why take on that much investment risk & stress to make an average of 1%?
It’s freeing to be mortgage free. I’m also trying to quickly pay down my 15 yr mortgage at a low interest rate. I don’t know what the future holds, so keeping expenses low will give me a peace of mind which is priceless.
I’m debt averse and only carry mortgage debt which I did refi at 2.75% fixed for 15 years with the credit union 14 months ago.
It is as much as a lifestyle choice as anything else.
Considered paying it off and decided against because of employment uncertainty… 23 years on the job means nothing these days as friends and coworkers find themselves unemployed.
There is another point that is missed here that is you can have additional freedom to do things like that just or even remove certain insurances that are required by mortgages. Even if done only temporarily, the savings can be huge.
If your point is that paying off your mortgage provides peace of mind, why did you bother doing the mathematical analysis? You could have just stated that and no one could argue with you.
I think your conclusion should be that paying off the mortgage has been a financial mistake thus far.
I have to agree with Zoolander on this one…
THUS FAR is the key
had the market been stagnant, or tanked, like it will inevitable do … then he is a genius
You end up saving hundreds of thousands in interest if you pay extra each month — and its a GUARANTEED return
how many people here are putting 100% of their left over cash into the market — I am gonna say no one
So why not put that left over cash into your mortgage, you are getting guaranteed returns plus shortening the clock
@Kevin: The reason I don’t put extra into my mortgage is because my GUARANTEED return is only 3.875% before taxes for the next 30 years. Historically short-term treasury bills have paid more than that, and they almost certainly will again at some point in the next 30 years. If someone approached me an offered me a guaranteed return of 3.875% but I had to lock up my money for 30 years, there is no way I would take it, so that’s why I don’t pay down my mortgage. I’d rather earn nothing on my cash for the next few years with the opportunity to earn a more normal, higher return in a few years, than lock in such a low rate for the long-term today.
Andy,
You have to subtract taxes from your returns. Assuming a 30% state+federal rate on interest income, you would have to make approx 5.5% returns on T-bills just to break even with the mortgage. You could argue that the mortgage interest deduction negates this, however that’s only true if you itemize deductions before the mortgage is added into the mix.
More like a 48-49% marginal tax rate including federal, state, and all the new surcharges. But yes, I definitely would itemize even with out the mortgage. So the post-tax rate on my mortgage is more like 2.3%. I’m pretty confident capital markets will top that over a long period of time.
Hang on .. I’m confused. In the recent post titled “The Power of Compound Interest Shown in a Single Chart”, didn’t you (Jonathan) suggest that a 7% market ROI is a reasonable assumption? If that’s true, and I agreed with you in that post, even thought that was not at all the point of the post … then why would paying down a 3.xxx% mortgage make any sense from a mathematical perspective? I completely get the emotional uplift .. but not the mathematical part.
How about this… I think it is a reasonable assumption that I will live past age 60. Odds are very high that this is the case. I can use then this simplification to show that I should save for retirement. But do I bet everything that I will? No, I have life insurance and I try to enjoy life today as well as save for tomorrow.
Going back, should I still save for retirement? Yes. Is compound interest + time still a very powerful combo? Yes.
Sounds like you have the right idea. This is a highly debated topic in the personal finance but as you pointed out there are no “coulda shoulda wouldas” in life, in hindsight you would have made more money investing in that ETF, but you never know what curve ball life is going to throw at you. You could lose your job tomorrow yet still have a HUGE liability that you still need to pay off and that (In my opinion) is not what people are factoring into their decision.
I can’t wait to pay off our mortgage!
If there house appreciated at all it should have been stated here. That could offset things a bit.
If their house appreciated at all, it would have happened whether or not they paid off the mortgage early. So, no, it has nothing to do with offsetting anything.
@Andy:
One thing you are not factoring in….is RISK (R). In the past 10 years, there have been a few market cycles with significant losses…so even if I had a “guaranteed 3.875% [% return]” every year, this would be much better than a year where I had a -35% avg loss (spread = -28-29% avg loss, when factoring in tax deduction for loss later on). Another way to look at it, Andy – if you you keep the mortgage, you have a Guaranteed loss every year…and if you flip the argument – the question would be: IF your mortgage is paid off like JPs, would you take equity out against it, to invest on the open market? Since R is still a big factor in that decision, I would not…
Also, someone correct me if I am wrong – but since a mortgage is more heavily front loaded with interest in the beginning years, based on the amortization level, I would think your “3.875%” rate is actually significantly higher – b/c you are required to pay more of it (tying up more $ in interest, and making minimal progress on the principal), correct?
Bottom line, for me (and why I paid it off in my early 30s): Mortgage interest, whether you call it “good” debt or not – is still debt. Everyone is trying to pay it down – as the ultimate goal is to not perish in debt (not good for your heirs) – so why try to slow down that process to 30 years? There is much more to the equation than just interest: R, piece of mind, and the freeing of significant capital to invest in other things.
Why? The main issue is missing on that good chunk of money that could have been put to work for you early/earlier on otherwise.
There are many examples out there. I think there was even a nice article and graph from Forbes on this but I am sure there are others:
“Let’s look at the following example: Sarah is 25 years old, and she decides to open a savings account dedicated to her retirement. She plans to contribute $5,000 per year, which is the equivalent of about $417 per month.
– If Sarah earns a 3% annual return and her bank offers compounding four times a year, by age 65 she’ll have $387,095.59 saved for retirement.
– If Sarah waits five years and opens the account at age 30–and still contributes the same amount and gets the same annual return–she’ll have $310,054.26 saved by age 65. The difference between starting at age 25 and starting at 30 is $77,041.33!
– If she waits even a few more years–say, until she’s 35–she’ll have just $243,707.04 in the savings account when she retires.
Even if Sarah “catches up” with those missed $5,000 annual contributions when she’s 30 or 35, her total won’t be as high as when she starts saving regularly at age 25.”
Funny, I was just catching up with older posts from Jonathan and found this https://www.mymoneyblog.com/power-of-compound-interest-2.html. Maybe it was here where I saw the graph? 😉
And yet rates on bank accounts have plunged at many institutions over the past year.
(CoughTCFBankCough). Jjust look at CDs. I never would have believed rates could have
gone DOWN from where they were….but yet, they have. I’ll never look down on
bank robbers again, LoL…..
Hmmm. You gave up a 15% return on your investments to pay down a 3% mortgage and you are happy about it. Not even the power of compound interest can compete with the power of rationalization.
I would be happy about it as well, that 15% return was over a short time period, with the market over extended right now I definitely think it was the best choice! It’s always easy to look back in hindsight and say “wow I should have put my money there” but guess what he doesn’t owe anyone anything now. If he lost his job and had to cover a mortgage with no income that 15% wouldn’t look so good would it?
Marvin,
Your argument is actually one of the best reasons for NOT paying off the mortgage. If he had not paid it off, and had lost his job, he would have a big pile of cash in the bank as a rainy day fund. Not only could he pay the mortgage with it, but also daily expenses.
Since he chose to pay off the mortgage, all that money is gone. If he loses his job, he will have to pay daily expenses from some other source, or go hungry.
Of course, the biggest problem with this article is, as you mention, the short-term hindsight. He needs to look at the statistical market returns over 10-30 years instead. Looking at 1 year (or one month, one day) provides no insight.
Reading this made me want to throw up a bit. Your blog was the first one I started reading Jonathan and you’ve always seemed like a great guy. But let’s be realistic here. Paying off your mortgage has reduced your short-term security. Your move was only the right one if you think the market is going to do poorly in both the short term and the long term.
I get that stupid people or people that don’t know anything about the stock market think that paying off your mortgage at these still historically low rates is the right move. But you are neither. It was the wrong move, the last year certainly didn’t change it being the wrong move.
My parents are the unsexy example of why being conservative with money is stupid. Throughout the 70s, 80s, and 90s, they invested very conservatively with a pretty decent combined income. They got divorced in 2004. Now my mom has maybe 100K in retirement, is house poor, and will be working throughout her 70s, and my dad will be retiring with 400K instead of the 800K or 900K he could have had. The “safe” approach is only safe in the short term…in the long term it’s actually the “risky” approach.
@David, I’m with you. I’ve been here since the early days , too. This blog had a zeal to it and was very objective and rigorous.
Parenthood?
I don’t quite agree. Yes, the article wasn’t the best, but paying off your mortgage has its merits.
In order to break even with a 4.5% mortgage, you would have to make at least 7% before tax, assuming you don’t itemize (many don’t, particularly in low-tax states). Even junk bond funds barely bring that much today. In other words, just to break even (not make money), you would have to take on substantial market risk that you can avoid by paying off the mortgage. In order to net 2-3% after tax (assuming an AVERAGE year-not 2013 or 2008), you would have to invest in foreign stocks or small caps. Why leverage yourself that much, and take that amount of risk for 2-3% net returns? If a recession like 2008 hits, and you become unemployed, you lose your volatile investments AND get foreclosed on.
I am with UDO & others who are against paying off mortgage at atime when the interest rates are historically low. And long term, it only makes sense. To address the part when the homeowner becomes unemployed etc, is where diversification plays a role. CDs and other assets that are liquid are good sources to reach out to while playing a substantial amount in the market. CD/Interest rates are low today. They wont be that way forever…
I am with UDO & others who are against paying off mortgage at atime when the interest rates are historically low. And long term, it only makes sense. To address the part when the homeowner becomes unemployed etc, is where diversification plays a role. CDs and other assets that are liquid are good sources to reach out to while playing a substantial amount in the market. CD/Interest rates are low today. They wont be that way forever…
Sometimes the math doesn’t always work in the favor of paying off your mortgage, but I have yet to meet ANYONE who regrets doing it.
I sure haven’t. Best financial decision I’ve ever made!
Maybe sometimes ignorance is bliss?
Maybe folks ignore or dismiss the importance of timing and the effect of compounding when it comes to investing and saving. Yet, they are the key – especially in the long run -. They are also the main reason why decisions like this one are costly, sometimes very costly, as history has had it.
Many folks also talk of “guaranteed” returns but seem to forget that 1 dollar today is not the same 1 dollar you would have to pay 10, 20 or 30 years down the road for your fixed mortgage. The amount on your payments will not change, but it would be a miracle if that dollar can still buy you a can of coke down the road.