You Wanna Pay Off Your Mortgage EARLY!?!?
“Get out of debt and stay out of debt.” All us financial advice writers talk about it, and we talk about it often. Debt can be a dangerous thing, and the safest debt is no debt.
If you can scrape together the extra money every month, throwing it on top of your regular mortgage payment gets you out of debt faster. Easy right?
That basic wealth strategy. But there’s a bigger picture to take a look at.
What’s The Opportunity Cost Of Paying Off Your Mortgage Early?
You’ve heard of “Opportunity Cost” right? It’s an expression that comes from economics. It means that you have two (or more) options, and you can only pick one. The ‘cost’ of one action is the second best action.
That doesn’t just cover money. If you decide to watch a football game instead of a basketball game, the ‘cost’ of watching football is the enjoyment of watching basketball. Scale of 1 to 10, football is a ‘10’ and basketball an ‘8,’ watching football gets you two extra points of enjoyment. Easy choice.
Saying “Get out of debt and stay out of debt” is blanket advice given to everybody. YOU, on the other hand, might have better options. Paying off the mortgage might be an ‘8’ – but what if there’s a ‘10’ out there you hadn’t considered?
Look at ALL Debt
The obvious first stop is Bad Debt. Make sure you’re making all your monthly payments on any loans and in particular your total monthly credit card bills — missing any of these means you’re paying interest and fees that you didn’t have to. You might as well be throwing money out the car window.
After that, look at paying off debts that have the highest interest rates, rather than the highest outstanding amount. Paying down debt in any other order means that you’re still throwing money out the car window, just less money out the car window.
‘OH SHIT!!!’ Money
‘OH SHIT!!!’ money is the cash that you keep off to the side for emergencies. There are situations that come up where you need cash on hand to keep yourself on the rails. The other half is to proactively set aside money for purchases you think you might make.
How do you get the best deal on a car? Have enough money to pay cash. “Zero percent loans” don’t exist – the extra cost is hidden in the numbers. Having the cash to pay upfront gives you a huge negotiating advantage helps you get a better deal with no financing at all.
What About Investing?
Things are weird out there. Good-weird.
Mortgage rates are low. So low in fact that you can probably find investments that are growing faster than your debt.
Let’s say for a moment you contact a Robo Advisor (an inexpensive online wealth management company) and they can set you up in a portfolio that balances itself. How big does the average rate of return have to be for it to make sense to invest that extra money you have every month instead of paying down your mortgage?
The obvious answer is ‘anything that’s higher than your mortgage rate’ (or the highest interest rate you’re paying on any of your debts). The not so obvious answer is that even if you’re breaking even, investing the money gives you more flexibility because it’s easier to turn that investment back into cash to be used for other things down the road.
To build on the last point, retirement accounts come with some special bonuses, one of which being the tax incentive. If you took that same investment portfolio with the rate of return that’s beating the mortgage rate and put it in a Roth IRA, now it’s growing tax free. That helps move along the compounding effect of the investment.
It’s also worth pointing out that if you work somewhere with an employer matching 401(k), max out that payment. If you don’t, you’re leaving money on the table. It’s part of your compensation package and part of what you’re worth.
Some older folks find themselves in the position where they want to retire but don’t have enough cash to pay for it and end up relying on a ‘reverse mortgage.’ Does that make sense to you? Why would you rush to pay down a mortgage just to turn around and take a new loan on the house instead of investing the extra money somewhere it grows on its own?
Looking at your options through the lens of ‘Opportunity Cost’ keeps the math simple, and the impact high. For some people it probably does make sense to pay down their mortgage faster, but don’t assume that it is.
Some people go crazy about paying down their mortgage faster just because it ‘feels better’ to see a big debt go down to zero. Forget about what ‘feels best’, make your choices around what is actually best.