” I did a study recently and 100% of all paid homes never end up in foreclosure! ” – Dave Ramsey
If there was an age-old question in personal finance, it would be whether to pay off your house early or invest that ‘disposable income’ and earn at a higher rate? When you pay off your house, you’re basically guaranteeing a return on your money of your mortgage rate. This is essentially the money you’re saving by not paying the interest on your mortgage. As an example, if your mortgage rate is 3% and you pay off your house in 5 years, you’re essentially guaranteeing a 3% return on your investment.
Now consider if you took that same money over those 5 years and invested it in the market. Most analysts will agree that a 6-8% return is achievable over discrete periods of time, like 5-10 years. If you compare the gains you would have made investing in the market instead of in paying off your home, it’s almost a no-brainer that paying your house off early isn’t the greatest idea…It’s almost a no-brainer.
Various articles are scattered all over the interweb with different takes on this very question. Being someone who has, at one point, paid off a house, I’ve read a lot of these articles with a fair bit of confusion and maybe a slight bias. I want to approach this question in a different way and ultimately, make the argument that it’s almost always a good idea to pay off your house early. Truth be told, while I use some numbers, the bulk of the argument is quite fluffy. I apologize in advance too my fellow money nerds!
Nobody ever says “I wish I didn’t pay off my house”.
Regardless of what your overall goals are, paying off your house can get you there faster. Do you want to buy more properties and create a real estate empire? Paying off your house will help you reduce your debt and enable you to leverage your paid off home to purchase a new house. Depending on how much your new investment property costs, you can even buy it outright in “cash” through a Home Equity Line of Credit and reduce the risk of spreading your limited resources too thin. Do you want to take a different job with lower pay? Paying off your house helps you untether yourself from a specific lifestyle by reducing your monthly expenses. So take that lower paying job… work freelance or start a business! You’ve paid off your house and doing so has increased your freedom substantially. Maybe your goals are more conventional; you want to have well-funded retirement and investment accounts. If you pay off your mortgage, the money that you would’ve spent on your mortgage every month will catapult you to a higher level of savings. Often, housing (rent or mortgage payments) are the single biggest expense we have in a given month and reducing this expense as early as possible can lead to a drastic increase in your savings rate much earlier!
Intentional living
Not everyone has the discipline and fortitude that you often need to pay off a house early. A big part of being able to do this is what I like to call “intentional living”, which was first illustrated to me in the book “Zen and the Art of Motorcycle Maintenance”. I’m a biker, so it really spoke to me. Basically, living intentionally can apply to anything in life. From motorcycle maintenance to personal finance (and paying off your house early). In the context of this article, it generally means living below your means. Do you really need those new clothes? Or to go out for lunch? Or to buy that coffee? Do you need that cable subscription and fancy home furnishings and appliances? Can you go on vacation and camp instead of staying at that five star resort? I’m not making the case to go out and become an uber minimalist (although that is cool and I’m personally trying to get there!) but we often spend money mindlessly and in order to attain big goals, like paying off your house, you often need to make big or radical lifestyle changes. One thing that’s helped me was stripping away everything but the bare honesty of the situation. Why do I want this shirt? Is this purchase masking a lingering body image issue that I have with myself? My dad used to tell me that if you’re comfortable with your body, you don’t need nice clothes. I fall back on that thought every time I want that gorgeous new dress from H&M and I’ll go for a run instead!
Money lending and spirituality
Yes, this is a weird one… but bear with me! It’s just some food for thought. Most world religions have rules around money lending. While the perspectives are different, they can be rooted in charitable giving, or just practical lessons about responsible lending and borrowing. An interesting example is the annual Islamic pilgrimage called The Hajj, which in recent years has seen millions of pilgrims visit Mecca. One of the prerequisites, in order to qualify to go, is to be debt free with the ability to finance the trip, as well as your family in your absence. While this prerequisite is extremely practical, it begs the question if being debt free makes your more spiritually ready for this pilgrimage.
Similarly, the book of Deuteronomy in the Hebrew bible has very specific restrictions on the interest and structure of money lending. The basis of all the rules, however, shows a clear benefit of not being indebted to anyone, in order not to be bound to anyone else. Each of the major world religions discusses charitable to the community, which can only be possible from a position of relative financial strength. There’s also an inherent freedom and lightheartedness in being debt free; in knowing that you are living your life proportional to your output and creative energy.
This might be a bit off topic but I recently had a debate with a co-worker who was making the case for leasing a car. Of course, in my mind (and practice!), you should buy a car outright and drive it for at least 10 years until it dies. I’m currently at 11 years with my car and 300,000 km! I really hope I have her forever… she’s an old friend, at this point. But my co-worker was making a case for 0% lease arrangements. He leased his Honda Accord for 0% down and a lease rate of 0.01%… almost nothing! The lease is valid for four or five years and in that time, he can’t exceed a set number of kilometers. What’s more, after the lease is up, he can just give back the car and get a new one if he wants! While this scheme is intriguing, I asked him what he thought about the philosophy behind it. He’s not breaking any laws and he’s almost helping the dealership by moving an older model car off their lot (apparently they only offer the ~0% financing on older cars that they just want to move). My question went like this: Let’s say you only have $5,000 in the bank and your cash flow (or income) is just OK. You wouldn’t be able to save $30k any time soon, if at all. Should you be driving a $30k car? If you exceed the kilometer restriction or there’s damage done to the vehicle that insurance won’t pay for, do you have the means to financially cover additional expenses? Will you be approaching the use of the car with the same lightheartedness you would if you had just purchased a used vehicle, free and clear, for $5k?
What can do you do?
For the path forward, I will broadly refer to the advice often given by the great Dave Ramsey. I find his approach to personal finance largely spiritual and appropriate for this article; although I don’t always agree with his specific advice. The most important thing you need in personal finance is a plan. Dave Ramsey outlines what he calls “baby steps”. In my opinion, your plan should start big and get specific. Do you want to pay off your house before your mortgage term is up? If you have 5 years on your mortgage term, you can use your prepayment privileges as a framework to determine what you need to save to achieve this goal. Maybe you want to pay it off in 10 years? How much will you need to save every month to make this possible? This plan shouldn’t exist in isolation… during this time you may also be saving for retirement, vacations, a child’s education or care for a family member. Paying off your mortgage needs to fit and balance with your other life goals and commitments. Some practical approaches include maximizing your bi-weekly payments and annual lump sums.
The main tool you’ll use to achieve your goal and realize your plan is intentional living. This includes being honest with yourself above all. Don’t keep up with the Jones’! If you don’t have $30k to spend on a depreciating asset (car), then buy what you can afford and live below your means. If your goals are aggressive, then you’ll likely need to live well below your means.