Note from Quinn: I am delighted to feature on the blog today a guest post from Jason Edwards. Jason is a Ph.D. and professor at Bridgewater State University in the Communications department. More importantly for this post, he’s an avid blogger on personal finance topics, and I respect his willingness to discuss financial issues and concerns openly and honestly with his readers. I encourage you to follow Jason’s journey here: http://www.reachingourbalance.com/.
There seems to be a never-ending debate among many in the financial community about whether or not you should pay off your mortgage early. For example, some people ask why should you pay off a mortgage when you have such a small interest rate. Ric Edelman, one of the leading financial voices in America, believes you should obtain as big of a mortgage as you can afford and take the money you would use to pay off the mortgage and invest it. And Edelman’s advice can make a lot of sense. If your mortgage interest is at 4% or less then you can most likely find investments where you will obtain a much better rate of return.
At the same time, there are others who think you should pay off the mortgage as soon as you can. Dave Ramsey is certainly one of America’s leading voices on finance. Ramsey is averse to debt of any kind and believes you should pay off your mortgage as fast as you can. In fact, he recommends that people only take out a 15-year mortgage that is no more than ¼ of their take-home pay. Once you have paid off the mortgage then you can take the rest of your money and invest it even further. I should note that Ramsey does advocate that you pay off all your non-mortgage debt first, build an emergency fund, then invest 15% of your income BEFORE you pay extra on your mortgage debt. Investing for retirement is NOT something that Ramsey advocates you delay in favor of fully focusing on paying off the mortgage.
Mathematically, Ramsey’s advice may not make the most sense. But, as he and others note, there is a true psychological advantage to having no mortgage and no debt whatsoever. You lower your risk and you lower your stress over money as well.
Both positions have their advantages and benefits.
Sometimes the mathematical answer is not always the right answer in personal finance because it is personal based upon your own situation.
Personally, I have tried to bridge the gap between both strategies. I decided to buy a much more modest house that would allow me to take the mortgage off quicker. When I bought my house four years ago I took out a 15 year mortgage at 3.75%. Two years later I refinanced to a 12 year mortgage at 2.875% and I now have about 10 years left on my mortgage. I could’ve probably taken out a bigger mortgage and gotten a bigger house, but I decided to manage my risk a little bit more with a more modest mortgage and terms.
That said, I do not pay a lot of extra on our mortgage. I personally do biweekly mortgage payments, which will actually pay off our mortgage about 2 years earlier, but I don’t go out of my way to focus on paying off the debt. I have decided to take extra income I have at the moment and try to max out other retirement vehicles.
At the same time, I am someone who despises debt. I know that if you I received a large lump sum of money I would pay off my mortgage in a heartbeat AND then take the rest and put it in the stock market. I know that mathematically that may not be the right position, but it really depends on your personal situation.
In order to determine whether or not you should pay off the mortgage first or invest more you need to ask yourself a series of questions. Here are some things to think about:
What are your attitudes about debt? Are you comfortable with it? Do you hate it?
What is your time horizon for retirement? If you are close to retirement and haven’t saved anything, but are close to paying off your mortgage you might want to ramp up retirement savings.
What does your current financial situation look like?
Are you a disciplined investor? Can you be disciplined enough to take extra money, put it into investments, and leave it for long-term financial planning?
Answers to some of these questions can help you decide your own answer.
While there is certainly this debate about paying off the mortgage vs. investing I do think there are some rules of thumb that I try to live by.
First, pay off your debt before you retire. Even though I don’t pay a lot of extra money on our mortgage I do believe in having ALL of your debt paid off before you retire. It will just provide your peace of mind as you move into your retirement years.
Second, save at least 15% of your income no matter what. If there is a choice between saving for retirement, saving for a house, and/or paying off the mortgage I will always err on the side of saving for retirement. Your house is an illiquid asset and unless you sell it it won’t help you much in retirement if you don’t have any savings. So if I have to choose I would dedicate myself to saving more for retirement, even if that means I would rent rather than own a house.
Third, don’t buy more house than you can afford. I think a lot of us certainly want the dream home/McMansion that we see on TV but getting into our “dream home” can be a stretch for a lot of people. I would personally advise people to buy a much more modest house than try to stretch the budget to get into a “bigger” and “better” house. Buying a modest house, paying it off quickly, and then using that house to get into your dream home would probably be a better strategy.
Finally, determine what your financial goals are. What are your financial goals? Do you want to own rental property? Pay for your kids’ college? Retire to some beach somewhere? Knowing your goals can help you create a larger plan. That plan then can dictate whether or not you pay off your mortgage early or not.
Let’s say you have been reading so far and you are adamant that you want to pay off your mortgage as soon as possible. There are some things you can do to accelerate this process.
First, switch to biweekly mortgage payments. If you are currently in a 30-year mortgage and want to pay it off early just switching your mortgage to biweekly payments will shave about 8 years off your mortgage and save you thousands of dollars in interest payments. You will have an “extra” mortgage payment per year, but it will pay off in the long-term.
Second, refinance your mortgage. If you can, you might want to refinance your mortgage to a 15-year or 10 year, particularly if you can get a better interest rate on that 15-year mortgage. When you refinance you might have to pay some closing costs, but the long-term interest savings may be worth it. A lot of credit unions are actually doing mortgage refinancing WITHOUT closing costs (I know my credit union does).
Third, throw any little extra money at your mortgage. Do you ever get small checks in the mail? Refunds? Tax returns? Why not just take that money and put it on your mortgage? Now if you have consumer debt or are living paycheck-to-paycheck this may not work, but even taking any money you receive, throwing at the debt, can add up to huge dividends later on. For example, I will get reimbursement checks for any travel I do. Most of the time I can cash flow that travel so I just take whatever reimbursement I get (which usually is only a few hundred dollars) and I throw it at the mortgage. Do that over a few years and you can eliminate a couple of years on your mortgage.
Finally, allocate future dollars to mortgage payments. Are you someone who knows that they will be getting raises? Bonuses? Increased compensation? Why not take that money and allocate a portion of it or all of it toward your mortgage. If you are already making it on the current income you have just don’t increase your lifestyle expectations and put that extra money toward your mortgage payment. For example, if you are getting a 3% raise every year, why not increase your mortgage payment by 3%. Just go to your bank, increase the automatic withdrawal on your mortgage payment by 3%, and you will never even worry about it. That slow increase can save you thousands over the years.
Should you have pay off your mortgage early? That is a great question and really is only one that you can answer for your own goals. You have to consider what your current mortgage balance is? What is your emotional relationship with debt? How much have you saved for retirement? What kind of investor are you?
Finding the answers to these questions and more can help you make the right decision for you and your family.