One of the most difficult decisions you can make as you struggle toward financial independence is deciding between paying off the mortgage quickly or investing the excess funds instead. The water is more muddy when we see a roaring stock market for as far back as the eye can see coupled with low interest rates. The answer seems simple and obvious: pay off the mortgage as slowly as possible and invest the difference in broad market-based index funds.
You might also think people well past the mile-marker of financial independence would have an even easier choice. Once the risk of a market decline passes due to your excessive net worth, it is tempting to automatically choose the course with the greatest opportunity for maximum gain.
Your favorite accountant has struggles with the same decision: pay it off or invest. It all came to a head recently when the topic came up on Facebook. I gave my opinion and the fur flew. Before long my inbox was stuffed with requests for a fully fleshed out explanation of my position.
For someone working his entire life in finance this shouldn’t be a problem, you’d think. But it isn’t that simple.
Any first year accounting student knows leverage (debt) can spike returns. Less understood—for reasons I can’t understand—is the effect leverage has when the investment goes down or even treads water. Leverage does enhance profits nicely in a climbing market. When the market goes sideways the interest expense of leverage starts to hurt. In a down market is turns brutal with losses magnified and interest accruing to rub salt in the wound.
When it come to real estate a false sense of security sets in. Unlike securities, real estate doesn’t face a margin call if prices decline. The bank will not borrow you more in such cases, but you don’t have to come up with more money over the regular payment. As long as things eventually turn around you are fine. At least that is the theory.
Armed with this information I begin my journey. I bought the farm (No, really! A beautiful 10 acre farm with hiking trails and a pond. What did you think? I died?) in the mid 1990s for $120,000. Five or so years later the mortgage was down to ~$40,000.
My old farmhouse needed serious work. We jacked up the house to secure the foundation, remodeled the original home and made serious additions. The Accountant household went from 950 square feet of living space to over 3,000. (No, I’m not proud of my extravagance.)
The remodeling and additions cost more than $200,000, all put on the credit card, aka, the new mortgage. The Accountant household had a serious debt now.
The good news is that I had no other debt and a net worth approaching eight figures. Our home appraised at $400,000 and change. Borrowing was relatively cheap and there was no real risk to such indebtedness in my situation. I did make payments well beyond the minimum to pay the house off sooner. (Some habits are hard to kill.)
By the time the world ended in 2008 – 09 I had the mortgage down to ~ $100,000, maybe a bit lower. The stock market tanked and I had plenty of room to borrow more against my home.
With my credit the bank was willing to give me pretty much anything I wanted. They needed to lend to low risk people and businesses and I was the lowest of risks. Since I have a farm I qualify for special loans only available to farmers. As luck would have it, I snagged a 2.125% loan fixed for 30 years!
Not being one for half measures I borrowed nearly $300,000, reducing my home equity to the lowest level in my life. I dropped the cash in the market.
It wasn’t a long wait. The market stopped declining and then started rising in fits and starts. For almost 10 years now my gambit has worked well. I made extra payments once again, but not as much as in past times.
Five years ago the mortgage was ~ $300,000. The market turned the borrowed funds into a bigger number. I refused selling the investments. But I increased my payments to reduce the large number on my loan statement. (It bothered me!)
Income from my practice now started going into loan reduction over more market investments. Yes, the market kept climbing, but I wanted that mortgage much lower. I found it disturbing to have the highest debt level in my life when I enjoyed the highest net worth of the same life. Even my business lived debt-free. This house thing, while a good move according to first-year accounting students, occupied my thoughts better used on other projects.
I also turned up the frugal. I learned to cut costs like a crazy man! Coupled with a nice business income I was able to shave $50,000 or more from the mortgage each year. My goal was to reduce the interest expense. Yes, the rate was low, but $300,000 at 2% is still $6,000!
Last year the mortgage collapsed to under $200,000. The race was on. Without resorting to asset sales I refocused my efforts to reduce the mortgage. By the end of last year the mortgage stood a hair into the six figures.
The Final Assault
There are several dry-erase boards around my office. Many are filled with cryptic messages on my personal and business finances. I use a type of shorthand known only to me. Sometimes employees ask what all the gibberish means. I tell them if it’s pertinent to their job.
A dry-erase board outside my office door has a series of numbers. The cryptic numbers were my madness to retire the farm mortgage. The original goal was to pay $56,800 on the mortgage this year, including interest. (Don’t ask why $56,800; it’s along story.)
As I entered summer it looked as if I could meet my goal. By late summer I met the goal for the entire year. Something snapped in my head when the mortgage hit $58,000 and change. I wanted it gone and now!
In the last two months I drove the mortgage from $58,000 to under $16,000. After I return home from FinCon in Orlando I will move money from a side business to retire the mortgage.
For the first time in my adult life I will be debt free before Halloween. That sounds so insane to me. I can scream “I’m debt-free!” to Dave Ramsey for the first time since the early 1980s while my net worth is well into the eight figures. I kept the mortgage to pad my net worth when the advantages would do absolutely nothing for my lifestyle.
And once again I was forced to reconsider my choice as the course of financially savvy individuals raked me over the coals on Facebook.
Why I Took the Course I Did
When I gave my opinion in a finance group on why I felt paying off the mortgage was better than investing the difference I was mobbed. In a matter of moments there was nothing left but a grease spot on the pavement.
My argument was simple. Paying off all debt not only reduces risk of default, but frees all the time spent thinking about managing the debt. That was my come to Jesus moment. I discovered I was spending more time thinking about my $300,000 mortgage than the millions I had in investments!
The mortgage was always planned. Payments were on automatic, but extra payments had to be considered. I also kept thinking about how long I wanted to keep this darn thing. Am I willing to keep a mortgage until I’m 70 just to kite the difference I could make in the market? The answer, once I seriously thought about it, was NO!!! And the more I thought about it the more I realized I was wasting quality time on a debt I don’t even need.
The only argument against my solution was that the market does a heck of a lot better than the 2 1/8% I pay on the mortgage. Once I thought about that I realized it was a stupid argument. Yes, it worked well for me since the market has been climbing with barely a hiccup for a decade. What they were really saying is that the ends justify the means. I disagree.
I won because the market was up a lot. How would I look if the market pulled a 1968 to 1982 when the market went nowhere for 14 years? Not nearly as smart, I would gather.
After careful consideration I came to the conclusion (took me long enough considering my age) that paying off the mortgage as fast as possible, regardless of tax deductions or the interest rate, is the only correct course. Here is why: The mortgage is guaranteed while the market is not. The market may climb or it could sink or stagnate. It’s happened for long periods of time. We sometimes forget our history. The mortgage is always there until paid, plus all the interest. No reprieve.
The other expense a mortgage has is time. Even with payments on automatic you still need to manage funds to make the payment. You either earn money or transfer from an investment into the account funds will be drawn from. Don’t forget or there will be penalties!
Time, more than interest or money, were the deciding factor. You might think debt doesn’t take time and allows you to spike your investment returns. Well, it does take time and thought and planning. That time comes from personal time. And debt is a harsh mistress when investments turn south.
I was a Dave Ramsey Endorsed Local Provider (ELP) for years. I have no problem putting every expense I can on the credit card. I pay it in full each month with auto-pay. I also make room for modest mortgage debt. I’ve changed my tune.
I think debt-free is the only way to go. Even if you have massive wealth outside the debt with zero risk to your FI (financial independence) status, it is still better to retire the mortgage on the primary residence, second home and rental properties. (Income properties do very well without mortgages, even in terrible economic times. Hard to lose when there are no monthly payments.)
There is one last thing I noticed as I approach the final payment on my home. Mrs. Accountant and I are giddy as school girls. (I don’t look good in a dress so no ugly comments.) Breaking the million dollar net worth marker didn’t get so much as a “Yippie!” out of Mrs. A. Every time I go to Farm Credit and drop another 10 grand or so she walks on air.
So do I. I must confess I feel a heavy weight lifted off my shoulders. I can’t believe paying off a debt that didn’t even register in the household budget affected my subconscious so much. But it did! It is impossible to understand how much debt affects you until you remove it. How much weight bares down on you until it is removed.
I always thought it was about how much I was worth. No more. I think you are a helluva lot richer without debt than with a massive net worth. I feel better about myself financially now than ever before. I always knew I owed somebody. Now that is gone and I can yell:
“I’M DEBT FREE!!!”
I hope you will join me. You can’t believe the colors on this side of the fence.
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Sunday 16th of December 2018
Keith, when I started reading this post I was prepared to silently debate you on why paying off the mortgage is a higher priority than investing for us right now. I wasn't prepared for you to make the argument for me and to do it so well!
My husband and I are $5k away from paying off our mortgage. We have one amazing daughter now, and my requirements before we can work on baby number two are 1) paying off our house, 2) having our daughter potty trained, and 3) me being back down to the weight and fitness level I was pre-baby #1.
It's nice to find an accountant who thinks like we do, and I'm curious to read more from your site to learn more about you and your against-the-grain ways!
Regaining Motivation When You Have No Debt
Monday 26th of November 2018
[…] of debate has also revolved around paying off the mortgage — any debt for that matter — versus plowing the excess payments into investments that pretend to offer a return greater than the interest rate on your debt. While investments can […]
The Benefits of Having a Mortgage | The Wealthy Accountant
Monday 19th of November 2018
[…] The debate is legend: should I pay off the mortgage faster or invest the extra instead? I recently finished that personal debate permanently. […]
Saturday 20th of October 2018
As a physician, I am a malpractice target in a somewhat risky specialty. Living in a state with unlimited homestead exemption if the property in a city is on one acre or less, I paid off my mortgage to make it creditor-proof (except from the IRS, of course)
Saturday 20th of October 2018
An excellent point, Ace. And one worth noting. The advantages to owning your home free and clear is more than just no mortgage payments.
Monday 1st of October 2018
Great article!! I caught the same crap from everybody telling me I was crazy to refinance my home loan to a 7 year loan fixed at 2.29 percent, thank you Tongass Federal Credit Union. Sure our payments doubled, but our term reduced from 30 years to 7 and after 7 years we will be debt free! I have a chalkboard at home beside our door with the numbers 4/80, and after making a payment today will be 5/79 to represent our number of completed payments to outstanding payments remaining. But we are taking it one step further, as I have the same obsession with being debt free as you do. Due to a recent job change, we have the ability to withdrawal all of our retirement savings (about 130K before taxes.) We will do this and take all of that money (approximately 95k after taxes) and stick it to our mortgage, effectively cutting our 7 year term in half. Now here is you another topic to write on: does it make sense to clean out your retirement account and take the 10 percent early withdrawal penalty? The answer will always be yes, for the same reason you stated above: In the 4 years we have contributed to the account, we are up over 50%. Thanks to Trump, our highest tax bracket has reduced from 28 to 24%, so now that 10 percent penalty is actually 6 percent compared to doing the same thing last year. My wife also went full time from part time this year, so the excess 95K will still keep us in the 24% tax bracket. Most importantly it is guaranteed like you said above whereas the stock market is not. I am 32, my wife 29. So after the remaining roughly 3 years of paying on the mortgage, we will be able to contribute and max out our 401ks, and IRAs, as well as taxable accounts, where currently we only put in the minimums for matching. I remember those people who lost their homes in 2008-2009 who only a year before had no worry in the world because they had a good job, and money in the bank. A year later they were homeless and bankrupt so to me the guarantee is always the right choice vs the gamble especially when it comes to your home. After the house is paid off, we will only have to come up with 200 dollars a month for taxes, plus regular cost of living such as cable, water and electricity. We also plan to cut back on our work from 40 hours each to 20 hours each so we can save money on child care and spend time with our children. And as a result of Obamacare, our children will be eligible for Medicaid under the expansion program when we reduce our hours, saving us from the possibility of medical bankruptcy due to illnesses of our children while saving us on our premiums.