Should I pay off my mortgage early?

December 12, 2006 8:18 PM

Should I pay off my mortgage early?

I recently, and unexpectedly, inherited quite a bit of money. I now have enough that I could pay off my mortgage, which has 25+ years left to go on it. There are no penalties from my bank for doing this.

I've asked my financial adviser and done research, and everything I can find just says it's an emotional decision. I'm in the USA, so there's a tax advantage to not paying it off right now, but I like the thought of not being in debt any more.

Have you had the same option? What did you do? Anecdotes welcome.

(Anon. because I don't feel like announcing to the world that I have a big chunk of change to spare. This means you, Dr. Clement Okon.)

posted by anonymous to Work & Money (18 answers total)

In part it depends on things like what your interest rate is, and how much money we're talking about relative to your mortgage.

If your mortgage interest rate is significantly lower than you could reasonably get from other investments, you'd be better off putting the money in those investments.

If the amount you have on hand is not at least twice your payoff balance, then you'll be putting all your eggs in one basket: your house. Granted insurance will cover most problems, but bear in mind that while owning your house outright is nice, it also gives you a lot of exposure to the vicissitudes of the housing market and acts of god (a.k.a. what your insurance won't pay).

In short, there's no one blanket answer, but those two questions are probably the most important in helping you come to a decision.
posted by George_Spiggott at 8:26 PM on December 12, 2006

Excellent response by George. I'd studying housing markets (if you are a subscriber to itulip, it has a pretty bleak outcast). Also your location is important for things such as housing insurance (I hope you don't live in So. Florida or NO...).

As long as your mortgage rate isn't egregious and your job is well salaried, I would assume that you could profit more by utilizing the tax break from the mortgage and investing the change in something like PMs or foreign exchanges etc...

Of course, there is more risk involved in the investment compared to the house, but the risk/rewards seems adequate (granted I don't know all the specificities....).
posted by stratastar at 8:34 PM on December 12, 2006

Once you look at the risk, the difference between the choices is probably a wash.

One way I've heard this question asked: If you had a paid off house, would you borrow money against it to invest? Most people instinctively say "no" to the question when it's posed this way, even though the math is exactly the same.

What would I do? Pay off the house, then build a pool to fill with all the money I'll make investing my old house payment. :-)
posted by griffey at 8:44 PM on December 12, 2006

The tax advantage comes from the fact that mortgage interest is tax deductible. Financially, you're better off paying the taxes than paying the interest, because the tax savings is only a portion of the interest payment. (e.g., if your mortgage interest is $1000 per year, you'd save, say, $400 in taxes each year you paid the interest. If you paid off the house this year, you'd pay the $400 in taxes next year, but you wouldn't have to pay the $1000 in interest.)

You are pretty unlikely to find an investment with a guaranteed rate of return higher than your mortgage interest rate. Given that, I'd pay off the house immediately, then begin investing the money you would have budgeted for the house payment. Plus, you get to live in a paid off house. Congratulations!
posted by decathecting at 9:05 PM on December 12, 2006

Please don't fall into the "tax advantage" trap. It's true when comparing similar mortgages and rent, perhaps, but you have to spend $3 and get back $1. That isn't smart.

Whether investing or paying off is right is another question, nicely summarized above. Just don't let the tax thing be part of the question.

Me? I'd pay the house off. With a paid-off house, your immediate income needs drop drastically--which means if you decide to drop out and sell rubber-tire sandals and sand candles from a roadside booth, you could potentially do so tomorrow without worrying too much about it.

The viccisitudes of the housing market only come into play if you anticipate moving soonish. If you know you'll be moving in two years, I'd not pay it off. Going to live there forever? I'd pay it off.
posted by maxwelton at 10:19 PM on December 12, 2006

I sold my old house for a profit and used saved money to payoff my current house at the closing. I can tell you from experience that griffey, decathecting and maxwelton (all above) are ABSOLUTELY RIGHT when they said:

What would I do? Pay off the house, then build a pool to fill with all the money I'll make investing my old house payment. :-)
-griffey

pay off the house immediately, then begin investing the money you would have budgeted for the house payment.
-decathecting

With a paid-off house, your immediate income needs drop drastically--which means if you decide to drop out and sell rubber-tire sandals and sand candles from a roadside booth, you could potentially do so tomorrow without worrying too much about it.
-maxwelton

I only add, the psychological feeling of waking up every day and not owing a dime on your house is indescribably great.

Pay it off.
posted by sandra_s at 7:03 AM on December 13, 2006

I had the same choice a while back and paid it off. Haven't looked back.

Since then I have recommended paying off the mortgage to all of my friends who have had the choice; 100% have since told me that it absolutely the right choice for them as well.

At the very least you should pay off your mortgage right now and see how it feels to own your own house for a while. You can always take out another mortgage later.
posted by tkolar at 7:08 AM on December 13, 2006

Pay it off. Don't rent money. There is no compelling reason to maintain debt UNLESS you are investing the money in a clearly superior fashion relative to the cost of the funds.

It MAY seem emotional, but in my personal experience, the fact that I haven't had a mortgage for the last 20 years or so has made a big difference in my outflows, my work life, my wealth.

If you do the math, you'll find it's far from emotional.
posted by FauxScot at 7:21 AM on December 13, 2006

The responses here are interesting. There seem to be two camps: do what's money-smart and invest, or do what makes you feel more secure and pay it off.

Paying off the house isn't money-smart. If your mortgage interest is around 6%, you can do better than that with long-term investments. And even if you only do 1% better (you could probably do 2-3% better), that's nothing to sneeze at when the principal is, say, $100K (I'm just guessing here). And while those returns aren't guaranteed, neither are you guaranteed to come out ahead if you invest in your house.

If you're saving for retirement or a kid's college fund, money socked away now will have that much longer to accrue interest, and more importantly, you'd be socking away and accruing interest on all that money at once—if you paid off the house and started "paying" an amount equal to your monthly mortgage into your investment account every month, you'd only be accruing interest on a much smaller amount initially, with ripple effects down the line.

I can understand and sympathize with the desire to pay off the house—I've had some lean times. But when I had the choice to either fund my retirement or pay (almost) cash for my house, I chose the former, and I have to say, I feel more secure for it.

Regardless, it would be a good idea to ask friends to recommend an investment advisor or a financial planner. An investment guy would love to talk to you, but he has a vested interest. You'll have to pay to see a financial planner, but he has no vested interest, and he'll walk you through the numbers.
posted by adamrice at 7:39 AM on December 13, 2006

From an email from my uncle: "If I would have taken the 250k I lost in the market and put it in my house, I would at least still have my house". Pay off the mortgage. Then take your current mortgage payment and automatically throw it into index funds. If its good enough for Google Millionaires its good enough for me.
posted by jasondigitized at 7:51 AM on December 13, 2006

Nope.
posted by BorgLove at 8:46 AM on December 13, 2006

I would vote for pay off the mortgage, and then invest the equivalent of your mortgage payment each month (or slightly less, if you would like more spending money).
posted by timepiece at 9:08 AM on December 13, 2006

I think looking at this as a purely financial decision is the wrong tack. Life isn't about money in the long run. It's about happiness. Personally, I'd be way happier with no mortgage, and presumably no car payments or any other debt.

How much would you need to live on with no debt in your life? You have been handed a rare opportunity to eliminate the primary source of stress in most of our lives, the stress caused by the need to get up and go to a job we don't really like because we need the money to pay our mortgage, etc. Absent that stress, you never have to work at a job you don't like. Hell, with no debt, you could likely work part time or for a non-profit you care about and still live quite comfortably. Or maybe not work for anybody. Start your own company, freelance, whatever. That kind of freedom is priceless.

Don't get caught up in rate of returns, although as demonstrated above, the math favors paying off the mortgage anyway.
posted by COD at 9:24 AM on December 13, 2006

You don't give enough information to answer the question, so I strongly suggest ignoring all the definite answers you receive. Things that are missing are the terms and rate on your mortgage loan, the location of your house, how long you've been in it, how much it's appreciated, how much you like living there, and your overall financial situation. Without knowing these things the question can't be answered sensibly.

I'd suggest taking a careful look at the article BorgLove recommended, though. It's a very compelling analysis of some of the "hidden reasons" why paying off your mortgage might not be a good idea.
posted by ikkyu2 at 12:30 PM on December 13, 2006

Pretty much what ikkyu2 said. I tends towards the "invest don't pay it off" crowd, but you really need to sit down and run the numbers in order to decide which is financially smarter. of course, if you would prefer to pay off the house, for the feeling of security it gives you, then do that. Neither is necessarily a bad decision at all.
posted by Joh at 1:21 PM on December 13, 2006

Jane Bryant Quinn, my favorite money management advisor, says that the best thing to do with a large windfall is put it somewhere safe for about six months--safe, not worrying too much about returns--while you do your research. That has always seemed like good advice to me. Last year when my partner's income suddenly almost doubled, I undertook such a research project, looking into how markets work, what investment returns look like, and so on. I read a lot of books with actual equations in them, and learned enough to make me skeptical of some of the claims in the article BorgLove links to--the author doesn't specify whether the returns he claims for other investments are the real returns after fees and inflation, for instance.

So my advice is to take your time, don't feel you have to act quickly, do some more research (there are some good threads here at AskMe about good books about investing, for a start), and then make your decision.
posted by not that girl at 1:56 PM on December 13, 2006

At first blush I would have said to keep your mortgage as is and to simply invest your windfall conservitavely. Why? Well lets assume you invest it and you don't loose anything, you don't make any money but you don't loose it either... If there's an emergency you can cash out the investments within a day. If you've paid off the mortgage but no longer have a well paying job you'll have some difficulty geting a loan on the house to help you out.

That said, after further thought, I'd say that you should take six months as "not that girl" said above and then if you still want to pay off your mortgage, pay it down but not off. Pay off half of it or 2/3rds of it. Take a good chunk of the monthly payment off but still have some cash left over for other investments and some liquidity.

If you pay your house off in full, you just invested 100% in the real estate market with zero diversification. Do it to get rid of stress, but don't do it for financial reasons.
posted by pwb503 at 3:23 PM on December 13, 2006

Here's how I would prioritize any windfall money as a homeowner. 1) Payoff non-mortgage debt (aka debt with interest over 6-8%). 2) Long Term/Disaster Savings. Put enough away in a near-liquid account to live on for 2 years. 3) Invest in your children or future children's education (use all available tax deferments here too). 4) Spend upto 5% of windfall on Fun over next two years. 5) Pay Mortgage down to equal 1/3rd of monthly income. Include food shopping, taxes, and insurance in that 1/3rd. Invest the money you're no longer paying toward the Mortgage. 6) Home Improvement. 7) If there is enough left over, then plan for an early retirement.

I would probably also give 5-10% to charity. Look at CharityNavigator for great 4-star charities in a field that's close to your heart.
posted by IndigoSkye at 10:16 AM on December 14, 2006