Over the last six months, the subject of paying down a mortgage early has been cropping up a lot. We’ll discuss the pros and cons of paying your mortgage early.
The Psychology of Being Debt Free
Debt is a heavy psychological burden, something that can keep up awake at night. And for most people, their mortgage is the biggest debt they have. So you can understand the appeal of paying off your mortgage as quickly as possible. It would eliminate your biggest monthly payment and give you the security of knowing no one can take your house from you (Providing you pay your property taxes!).
But that strategy can be short-sighted. I have a real-world example. A couple I work with who are in their mid-30s came to me to discuss the idea of paying off their mortgage in five years. This is because they are anticipating a big career change in the next few years and felt that paying off their mortgage before making that move would give them more flexibility. I’ll talk you through what I talked through with them.
Paying the Mortgage Off in 30 Years
Let’s look at some numbers:
- $330,000 mortgage
- 6% interest rate
- 30-year mortgage
- $1,800 monthly mortgage payment
- $210,000 paid in interest
- $540,000 paid in total
That’s a lot of interest, nearly ⅔ of the cost of the house! You can see why paying off your mortgage early is appealing.
Paying the Mortgage Off in Five Years
Now let’s look at the numbers if you pay the mortgage off in five years:
- $330,000 mortgage
- 6% interest rate
- 5 years to pay off the mortgage
- $1,800 + and additional $4,500 for a total monthly mortgage payment of $6,300
- $31,000 paid in interest
- $361,000 paid in total
That is a tremendous savings in interest, $179,000!
Paying the Mortgage Off in 15 Years
Now, let’s see what happens if we find the happy medium and pay off our mortgage in 15 years after refinancing our 30-year mortgage:
- $330,000 mortgage
- 25% interest rate after refinancing
- 15 years to pay off the mortgage
- $1,800 + and additional $661 for a total monthly mortgage payment of $2,461
- $59,000 paid in interest
- $389,000 paid in total
We’ve paid an additional $28,000 in interest compared to our five-year scenario but still $151,000 less than in our 30-year scenario. The 2.25% rate we got on our refinance may not be available now as, at the time of this writing, interest rates are going up. But that rate was possible until fairly recently.
The difference in our monthly mortgage payments between the five-year and the 15-year scenarios is about $3,800. If we invested that difference for 15 years at 6%, we’d have just over $1 million.
In the first few years of investing, even a pretty hefty monthly sum like our $3,800, it doesn’t seem to be adding up very quickly. But in those subsequent years, compound interest really starts doing its thing, and our money grows at a pretty impressive rate. Those early years of investing are the first bricks in the foundation of our secure financial house.
Whenever we make a choice, we’ve given up something else, the thing we didn’t choose. If we had steak for dinner, we didn’t have fish. If we went to Hawaii for our vacation, we didn’t go to France. Say we pay off our mortgage early, then we didn’t invest that additional money in the stock market. The choices we didn’t take are our opportunity costs.
If you were making a significant career change, leaving the corporate world for a start-up, or leaving your career to start your own business, what would be the most useful thing to have? Security right? Because the start-up or your business could fail, and you would be without an income for some amount of time. But what would give you more security, having no house payment or having a big lump sum of cash to fall back on?
It would surely be the cash. Having no housing payment doesn’t magically eliminate all of your other expenses, your auto payments, insurance costs, utilities, food, and all the other expenses we all have. And how would paying off your mortgage in five years impact your retirement saving? Taking a big chunk of money out of long-term investing to pay off your mortgage so early may mean your retirement portfolio won’t be able to generate enough income to see you through your retirement, the biggest financial fear most of us have.
The Role of a CFP
As I wrote, this was an actual scenario that clients of mine came to me with. What did they decide in the end? They went with the 15-year payoff plan. This saved them a ton of money on interest while giving them a big chunk of cash to see them through the career transition and not having such a negative impact on their retirement investing.
When many people think of CFPs, they think of someone helping you choose stocks and other investments. But the mortgage scenario is a perfect example of the kind of situation where working with a CFP is really valuable and creating a financial plan as a tool to evaluate options. A CFP professional can help you zoom out, think things one step further out, and point out opportunity costs.
A great CFP can help you Create The Life You Love. If you have questions about your mortgage, opportunity costs, or anything else related to your financial plan, schedule a meeting today!
Listen to the Full Episode:
What You’ll Learn In Today’s Episode:
- How to know when it’s the right time to pay off your mortgage faster.
- The behavior and psychology of money and investing.
- How a financial planner can help you weigh the pros and cons.
- Other alternatives to consider over paying your mortgage off as quickly as possible.
- How to factor opportunity cost into the equation.
Ideas Worth Sharing:
“If you take a big chunk out to pay off your house, it’s going to cause some risk in your portfolio to generate the amount of income that you need in retirement.” – Jonathan Bednar
“Whatever life looks like in five years, you would at least have a lump sum of cash.” – Jonathan Bednar
“One of the biggest assets you have is time—the longer that you have to let your money grow and compound, the better off you are.” – Jonathan Bednar
“You definitely want to have cash available so that if the storm happens, you’re not cash-strapped.” – Jonathan Bednar
Resources In Today’s Episode:
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