Why Paying Off Your Mortgage Isn’t Always the Best Strategy

This is something of a controversial topic. Ask just about anyone in the personal finance arena, and most will tell you that you need to pay off your mortgage as soon as possible. The basic concept is enabling yourself to live “rent free”, so you’ll have more money for everything else. It’s hard to argue with that concept, however paying off your mortgage isn’t always the best strategy.

Let’s consider the reasons…

Opportunity Cost

There is a cosmic rule when it comes to all things money related: anything you spend money for or invest money in will cause some other area of your life to go unfunded. And so it is when you put more money into paying off your mortgage.

The fact is, paying off your mortgage is not a completely risk-free proposition. Committing money to such a large undertaking can cost you money other areas.

Three prominent examples:

  • If you are using extra cash to pay off your 4% mortgage, you may be losing out on an 8% return in mutual funds (not guaranteed of course, but well-supported long-term)
  • If you have non-housing related debt, it will make little sense to emphasize paying off a 4% mortgage, while leaving credit card debt with double-digit interest rates unpaid
  • No matter how much equity you have in your home, if your bank account is empty (or close to it) you are virtually house poor – sitting on top of a lot of equity, but struggling to pay the bills every month
Why Paying Off Your Mortgage Isn't Always the Best Strategy
Why Paying Off Your Mortgage Isn’t Always the Best Strategy

Now if you already have a substantial amount of money invested in mutual funds, and are able to continue increasing it while paying off your mortgage early, then it’s certainly worth doing. But if you have to make a choice between paying off your mortgage and either having money invested in mutual funds or used to pay off high interest credit card debt, paying off your mortgage will have little positive impact on your life, particularly in the short run.

It’s important to understand that there is little benefit to paying off a mortgage early until the loan is fully paid. This is because your monthly house payment will remain the same whether you owe $100,000 or $10,000 on it.

This is precisely why it is so important to have your non-housing financial situation under solid control before even considering paying off your mortgage.

Too Many Eggs in One Basket

If your home is your largest asset, you will only be increasing the amount of money sitting in it by paying off your mortgage early. If for example, you have $100,000 equity in your home, but only $2,000 in the bank ? and no investments ? your financial situation is completely unbalanced. It means that substantially all of your money is in your house, and that’s way too much in the economy and job market we are now in, and seem destined to stay in for the foreseeable future.

That creates another problem with paying off your mortgage…

Loss of Liquidity

It’s been said that “you can’t eat a house”, and never is that more true when you are facing a career crisis or a time of financial struggle. The problem with a large home equity position is that it is not readily convertible into cash. That limits its usefulness to something close to zero.

There are basically only two ways that you can get cash out of a house. The first is to sell it, which few people are willing to do even and especially during a time of financial distress (many even stay in the home until the sheriff comes repossesses it).

The second is to borrow out the equity. While that is far less traumatic than selling the property, it puts debt back on the house, reversing the effort to pay it off. As well, if you are facing financial difficulties, such as the loss of a job or impending bankruptcy, it?s very unlikely that you will be able to qualify for a second mortgage, a home equity line of credit (HELOC), or even a new first mortgage.

Unfortunately, most methods to cash out equity from a house during a time of financial distress are nonexistent. This is also why so many people lost their homes to foreclosure in the last economic crisis.

Loss of a Major Tax Deduction

The reality of today’s federal income tax code is that there are far fewer tax deductions available to the average household than there were a generation ago. But the one that has remained nearly untouched ? for political reasons ? is the home mortgage interest deduction. You can no longer deduct consumer credit interest, and even deductions for medical costs and employee business expenses are largely nullified by the fact that they must exceed a certain percentage of your adjusted gross income. For most taxpayers, that leaves only state and local taxes and mortgage interest as substantial deductions.

The ability to deduct home mortgage interest matters because it effectively reduces the interest rate you are paying on your mortgage. For example, let’s say that you are in the 25% tax bracket for federal taxes, and 5% in your state. If you have a 4% mortgage, the tax deduction means that you will be reducing your mortgage rate by 30% (25% + 5%). That reduces a 4% mortgage rate to an effective rate of just 2.8%.

Why would you want to lose that deduction, and why would you want to pay off a long-term loan with an effective rate of 2.8%?

One More Thing: There Really is No Such Thing as Living “Rent Free”

Finally we come to the ultimate reason that people want to pay off their mortgages ? the promise of living rent free.

In reality, that’s really a fantasy. Even if you pay off your mortgage, you will still have to pay real estate taxes, homeowners insurance, property repairs and maintenance, and, if you live in a neighborhood association, homeowners association dues.

If your annual property tax bill is let’s say, $6,000 (or $500 per month), adding this to all the other expenses required for homeownership will get you to about $1,000 per month in a hurry. And that?s even without having a mortgage payment.

Now it’s true that paying off your mortgage will get your payment down to that level, which is not unimportant. But the fact is you will still not be rent free in any sense of the term. Yes, your monthly housing expense will be lower, but you will hardly be rent free.

Considering all of those limitations, do you really want to pay off your mortgage as soon as possible? I’m not making a case against paying off your mortgage in time for your retirement, but rather against doing it anytime much sooner.

( Photo by david_shankbone )

7 Responses to Why Paying Off Your Mortgage Isn’t Always the Best Strategy

  1. You left the BIGGEST factor out of your equation – PEACE OF MIND!!!!!!!!!!
    Paid our mortgage off and couldn’t be happier about it. The (lost) tax deduction, hoa fees, taxes, etc – ha! drop in the bucket.

    Everyday I go to work and think, hmmm, if someone pisses me off too much today, screw it. I’m out and I think I’ll take a little trip to a tropical island.


  2. Well put Jim! There are the non-financial factors, and I have to agree, having a house that’s paid for can be REALLY GOOD for your emotional health. But I still think the financial side favors leaving the mortgage out there. It’s passive, self-amortizing debt, and if it’s a fixed rate loan, it won’t threaten your financial situation. Then, at the end of the term, it will just go away. Perfect! (Or at least, the perfect kind of debt, if we can say such a thing about any debt!)

  3. My wife and I have been reliably paying our mortgage for the past 10 years – first starting out at 30-year, then 20-year, then 15-year refis. Currently, we are paying only $8/mo more than when we started on our 30 year, 4 years into a 15-year mortgage @ 2.75%. Our payment is about 20-22% of our net income depending on how much my wife works, but that bumps up to 33-35% if you include our outrageous property taxes in our fair city.
    I have taken to heart your cash flow arguments. It looks like I could do a cheap rapid refi for $149 at our credit union into a 12-year mortgage, but that would only reduce our monthly payment by about 50 dollars. 15-year would reduce by 200, 20-year by 300, and 30-year by 400+, but with higher refinance expenses. Is it worth it to go out further to increase our cash flow, say to a 30-year with 5000 more a year cash flow? Not to mention a $450/mo house payment would be crazy and especially advantageous in this low interest rate environment.

  4. Hi Kevin – Based on your numbers, it looks like you have 11 years remaining on the current mortgage. You have a low interest rate, and you don’t seem stressed by the payment (though I think 33-35% of net income is on the high side). What you haven’t indicated is the loan-to-value on the house. That’s how much your mortgage amount is compared to the property value, expressed as a percentage. If you owe $100,000 on a $200,000 property, I’d stay with the loan you have until it’s paid. Your rate of 2.75% makes it virtually impossible to get a lower rate, and you’ve already refinanced three times. Adding a fourth doesn’t make much sense, due to the closing costs, and loan-reset factor (going back to payment #1 with the new loan).

    I prefer a lower payment spread out over more years, but in your case, you’ve engineered your mortgage for early payoff. I’d stay on that course, and stay with the loan you have. In 11 years it’ll be academic as you will have accomplished your original mission. Now if the currently monthly payment is a problem, I’d seriously consider moving back to a 30 year loan. There’s much to be said for a very low house payment. You would even be able to make prepayments as the funds become available to do so. Think long and hard about this, and discuss it with other people and advisors who you trust.

  5. Actually, just refi-ed twice from 30-year to 20-year then 15-year. Reason I was thinking of the 12-year is because the closing costs through the credit union are low, but as you say, the interest rate just won’t go any lower than 3% which is higher than what I have now.
    Loan to value: I owe almost 100,000 (a psychological level) on a 300,000+ house (originally paid around 250 K)
    I can see advantages of staying the course. However, we may have some home repairs/improvements and that extra 400+ a month with a 30-year loan would be nice to have if need be.
    I don’t know if I would call our payments a problem, but that property tax bill every year ( we don’t escrow) keeps going up (expensive Madison WI). Our kids are getting older, but my wife probably won’t want to work more than part-time which is OK. At times, I have thought about switching careers too, which would more than likely involve a decline in pay.
    So, maybe my dilemma is not necessarily related to my mortgage 🙂
    Thanks for your reply!

  6. I am 46 and have just paid a $275,000 mortgage off in 12 years. I tas very difficult but I feel on top of the world now. I’ll never forget the relief I felt in March when the market took a huge hit. And all these negative articles talk about making a profit if invested in the market. I never hear about smart investing against bad investing. All these scenarios have the person coming out making a 10 percent gain. That’s not always the case. I know many people that listened to their buddy’s hot stock tip and got crushed. One example is Avis stock. It was 52 bucks before covid and went down to 7 practically overnight and hertz is practically worthless. It’s crazy how everybody just assumes people will invest slow and steady and get their 10%. The mental part of investing send many people to the poor house. Especially in a volatile market like we have now. We makes the market even nuttier is all these new robinhood investors who have no idea what they are doing. They read one positive article about a company ant put their life’s saving into into it and buy on margin on top of it. OK. rant over. LOL

  7. Hi Tom – You’re actually making a good point. In the article I wanted to challenge the notion of paying off your mortgage as a priority goal. I still don’t think it’s the right strategy for most people. But you make a good point. The returns in the market aren’t guaranteed, and certainly the average person won’t get 10% per year. But statistics have shown a balanced portfolio can get higher returns over decades than you’re paying in interest on your mortgage. Now if mortgage rates were 8% instead of 3% – 4% I’d have a different take. But in this very low rate environment there’s a strong case for keeping your mortgage going and investing your money instead.

    The other part is that if you can increase your savings and investments for say, the first 15 years of your mortgage, you may have enough put away to pay off your remaining mortgage balance while still having a decent nest egg. When it comes to money we have to look at our situations from several angles.

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