Last updated on February 10th, 2019 at 12:11 am
Some of the most common questions asked on blog sites are
- “Should I pay off my home early”?
- “I will retire in x years, should I have a mortgage payment”?
- “I want to pay off all of my bills and have no mortgage payment when I retire!
- “Is there a better alternative than paying off my mortgage early”?
There are many variations of the questions above and this article will hopefully shine some light on your decision. Starting with the idea that owning a home free and clear is a dream that most have, let’s explore the psychology of owning a home without a mortgage.
People just seem to believe the not having a mortgage is a goal and some work hard to get to that goal. Others believe that paying off a home is a bit like paying off a car. Most people do not stay in a home more than five years just as many people do not own their car until it is fully paid off. Essentially your home is leased to you in the sense that you are making payments to an entity that legally has the right to take it back if you fail to make payments.
Perhaps it’s the idea that if something happens at least you will own your home or that if you lose your job, your monthly obligations will be lower. Keep this in mind as we discuss some concepts later in this blog post.
Some people who are working on their retirement plans have decided that their income will be lower in retirement and they have decided to avoid a monthly mortgage payment and pay off their homes before or at retirement time. Makes senses, right? Hold that thought as we move further into this psychology of mortgages concept.
Some younger people are making fabulous money and have to put it somewhere. If they are lucky to live in an area where their high incomes permit them to buy a home in a modest cost area, they may consider paying off the loan early. After all, what do you do with all that income? It truly is a good feeling not to have a mortgage or rent payment. I know, for many years I did not have a mortgage payment (No, I was not living in my parents basement).
The feel good concept is universal, after all, no one wants bills of an kind. Unfortunately some monthly bills are unavoidable e.g. utilities etc. Back to that fear thing about what happens if? Most of my readers are old enough to know real fear after remembering the horror stories of the first decade of this century. Yes, the mortgage crisis or sub-prime crisis or the Barney Frank debacle. Lives were affected and not for the good in most cases. Property lost value and jobs went away. People lost their homes.
Readers can fully understand the obsession of some to have no mortgage particularly if they are near retirement. So we all get the concept. Zero mortgage means financial stability and allows those who have achieved this to breath a bit easier, until…..
One reason I am writing this article is because I have answered many, many questions on Quora about this topic and I have a personal story to convey. Here is my thinking about owning a home without a mortgage and how I made a decision to pay cash for a new house about 10 years ago and why it made sense at the time but no sense later.
I had decided to sell my company to a very, very big company. It was part of my retirement plan although I was not ready for retirement at the time. I had decided to buy a new home before I sold my company and found one just after the sale was closed. I had planned to finance the purchase and use the money for something else (we will get to that later).
Due to some glitches in the deal, I was not able to get escrow closed in time to complete the purchase of this new home. The company had just reduced the price by 15%, something that builders prior to that time never did. I had to pay cash for my home. Ok, that was that and while I was busy with the transition of the sale and other investments, I kept avoiding this nagging feeling that something was wrong.
I did feel good about not having a mortgage payment, the first time in a few decades. Some would have dropped that into a social conversation e.g. “Yes, it’s nice not to have a mortgage” or when asked what interest rate I was paying, I said “zero”. Perhaps I did make mention on a few occasions. Yes it was nice not to have a mortgage payment. Well, partly. I still had to pay the property taxes twice per year and the annual hazard insurance so it was almost nice. Of course since I had to pay the taxes and insurance directly it brought those costs into more focus for me and that’s a subject for a different blog (I discuss it on one or more of my posts).
That feeling of something was wrong turned out to be the idea that mortgage interest rates at the time were about 2.5% and the stock market was returning about 10% (one year it was nearly 30%). I did a quick back of the envelope calculation one day and to my horror, the opportunity to earn more was slipping by. A significant amount of my net worth was tied up in my house.
At that point, I decided to obtain a new first mortgage which I did. Since I knew that I would be living in the home just another few years, I opted for a variable rate mortgage with a 3 year fixed payment. The interest rate was 3%. I was enjoying a spread of about 5% (sometimes more but we all know what has happened to the stock market of late).
My situation above is the reverse of what I am writing about that people want to pay off their mortgage. This example is one of being where some want to be, not having a mortgage. The point is to give some perspective to those who would otherwise pay off their homes and then some day understand that there are options.
To dive into this further, I have some calculations for you to understand. They are as follows:
- $250,000 mortgage
- Interest rate 4.5% (see current mortgage rate table below for MS, my example is dated)
- 30 year fixed
- Monthly payment $1,266.71
The above represents a sample mortgage. Perhaps yours is more or less but you will get the point shortly. Now for the investment. Assume that you invested the funds that you were going to use to pay off your mortgage:
- Initial investment $250,000
- Subsequent investment – $0
- Withdraw $1,266.71 each month to cover the mortgage payment above.
- Investment rate of return 8%
- 10 year investment period
I picked 10 years because most people sell their homes after 5 years and few go to 30 years. (click here to use the actual calculator that I used for this analysis)
After 10 years of taking out enough to cover the mortgage payment, the balance would be $321,572. Remember, you put in $250,000. The return on investment is greater than the amount you are withdrawing so the principal was never touched. In fact, the principal grew.
Now compare paying off the mortgage with the $250,000 after 10 years. Where would you be financially? You would own a house without a payment and your $250,000 would not have grown. In fact, the principal would have been reduced through inflation if it were not for the equity growth in the home which happens mortgage or not.
[mlrates state=”ms” size=”wide”]
This is a dramatic comparison of your decision to pay off a mortgage or invest those funds. This is how people who invest in real estate become rich. In this case it’s your own home that is making money for you.
Heaping more on the idea of having a mortgage rather than paying off the home are some benefits. Most people will not be able to take advantage of filing schedule A to the annual 1040 income tax filing because the new standard deduction is at or greater than $24,000 for a married couple. The idea of the mortgage deduction for most is no longer something to consider but for some this will be an added benefit.
Your credit score will be better if you have a mortgage. This is a key indicator for potential creditors. While your monthly payments may be higher in total, you can show the income from your investment as an offset should you wish to buy something on credit e.g. a car or a rental house.
Perhaps the best benefit other than the addition income you earn from the investment is that you have access to funds in an emergency. Depending on what you invested in e.g. equities that can be liquidated quickly, you may have ready access to funds for things such as medical. If the funds are tied up in your home the only way to get to them is to obtain a HELOC or refinance. These are costly and take time.
History is in our favor now. Years ago during the Regan administration, home interest rates were in the 17% range. The stock market was at that time returning about 10% so there would not have been a spread to work with. This is truly a unique time in history where the average person has the opportunity to borrow at one rate and lend out at a higher rate. In a few years this blog may be out of date if mortgage rates climb to the 7-8% range and the stock market is generating the same return.
Some readers will fully understand the concept laid out above and decide to pay off their mortgage because the idea of not having a payment means so much to them. Others will see the potential and create a plan to make it work. People planning on retirement who understand that Social Security is not the gold mine that some expect can perhaps understand that they need all of the strategies they can find to maximize their savings. The idea of investing rather than paying off the mortgage may work for them.
Another off shoot of this concept is to obtain a new first mortgage and pull out the maximum amount of equity and invest it. The concept works as well that way too. You may consider selling your home and moving to a lower cost area in retirement. At that point, you will have funds to invest. There are zero interest mortgages provided by the VA and USDA.
Run the numbers and see what works best for you.
Note: The first page of the savings withdrawal report that this article used is included below:
