December 2017. Congress passed a new tax law. The expanded standard deduction meant I wouldn’t get any tax benefit from carrying the mortgage starting in 2018. I decided to pay off my mortgage in 2018. At the end of 2017, I owed $253k.
April 2018. I left my full-time job. After making extra payments with cash from vested stock awards and unused PTO, plus a few months of regular payments, my mortgage balance was down to $197k.
October 2018. After making many additional principal payments, plus the regular monthly payments, my mortgage was finally paid off. I had to do it by paying $10,000 at a time because Chase limited additional principal payments scheduled on its website to $10,000 per day.
Maybe it’s time for me to write “How I Paid Off $250k Debt In 10 Months” or “How I Paid Off $197k Debt In 6 Months With No Paychecks” but let’s not go there. Although I’m glad I met my goal, it’s remarkable what paying off the mortgage didn’t do.
Not Debt Free
Paying off the mortgage didn’t make me debt-free. I still have a loan on the new car I bought late last year. The loan is at 0%, but it’s still a debt. Even without the car loan, I still owe up to several thousand dollars on my credit cards on any given day. You do too if you regularly use a credit card. It doesn’t matter if you pay in full every month. Log in to your credit card website and look at your balance. That’s your debt to the bank as of today.
It’s called revolving debt. By the time a payment hits and it pays off the balance in the previous cycle, I already owe money charged in the current cycle. No payment is due yet and I won’t pay interest when I pay in full every month but it’s debt nonetheless. Because of this, I don’t expect to be debt-free, ever.
Debt-free or not debt-free doesn’t make much difference to me. I can have debt and have more assets, or I can have no debt and less assets. Either way works. It’s all about the rates, what I’m paying and what I’m receiving. Trying to be debt-free purely for the sake of it is only psychological, not necessarily financially beneficial.
No Increase in Net Worth
Not all cash outlays are expenses. Knowing the difference between cash flow and income/expense is very important in personal finance. From the previous post Savings Rate and Mortgage Loan Payments, we already know that the principal part of the mortgage payment isn’t an expense. It’s savings if you pay from your income, or it’s merely a transfer from your left pocket to your right pocket if you pay from existing assets.
I used proceeds from matured CDs to make the extra payments on my mortgage in the last six months. Money went from my left pocket to my right pocket: CDs down, home equity up. My net worth didn’t increase just by moving money around.
Housing Cost Didn’t Plummet
After I paid off my mortgage, although I stopped paying interest to the bank, my total housing cost isn’t going down. In some ways, my total housing cost will increase.
The interest portion of the mortgage payments was indeed an expense. It did stop, but I also increased another cost: the opportunity cost. I used to earn interest every month on those CDs. Now I don’t when those CDs are gone. The drop in the interest earned is quite visible. My mortgage rate was 2.5% fixed. I would earn 3%+ on new CDs if I didn’t pay off my mortgage. It’s about a wash after paying taxes on the interest income. If interest rates go up, with all taxes factored in, eventually I will forego more interest income than I eliminated my interest expense.
Just like the largest cost of early retirement is the opportunity cost, the largest cost of owning a home free and clear is the opportunity cost of the money tied down to the home. The foregone income the money could earn is just as real as the interest you would otherwise pay to a bank. Whether to pay off a mortgage depends on the difference between the interest rate you pay and the interest rate you earn, and your preference for liquidity. Not having a mortgage doesn’t change your total housing cost that much when you include the opportunity cost in the full picture of your housing cost.
We sometimes read someone only spends $X a year. When that low number is based on owning a home free and clear, it doesn’t include the full cost of housing. It’s not directly comparable to someone else who pays rent or has a mortgage. The lifestyle afforded by spending $X with a paid-off home is much higher. If I start telling you I only spend $60k/year, the true total cost is more like over $100k/year.
Property Tax and Insurance
The bank will return the escrow account balance to me. The escrow account never bothered me because the account paid 2% interest, which was higher than the interest rate in my own savings account. The bank used to take care of paying the property tax and homeowner’s insurance bills. Now I’m responsible for paying those bills.
Paying for homeowner’s insurance is easy because the insurance company offers autopay. The county doesn’t offer autopay for property tax bills. They have to be paid manually. It’s going to be a problem if I happen to be on an extended international trip when they send out the bill. I set a calendar reminder to check and pay the property tax bill.
Not The Best Financial Decision In My Life
Some say paying off their mortgage was the best financial decision in their life. I didn’t experience that kind of joy at all. Paying off the mortgage was very low on my priority list. I waited until now to do it. I don’t regret doing it but I don’t see it as something to celebrate either. I won’t hold a party to burn my mortgage note.
Loss aversion says we feel twice as much pain from paying interest to the bank as the joy we get from earning interest. This behavior bias motivates people to pay off their mortgage.
Paying off the mortgage was mostly a wash to me, maybe a slight net negative over the remaining life of the mortgage, because my 2.5% mortgage rate was very low. The calculation would be different if my mortgage rate were 3.5%, 4%, or higher. I did it because now that I don’t have paychecks, I’d like to lower my overhead. It makes my cash flow a little easier to manage. I don’t need the leverage to earn more on this amount. I don’t need the liquidity. I don’t mind increasing my opportunity cost.
Many other financial decisions in my life were far better than paying off the mortgage. I don’t see owning a home free and clear as a status symbol. Increasing your net worth is important. Only changing the structure of your net worth — more investments or less debt — is not as important.
When you hear someone paid off their mortgage, congratulate them on their act of saving the money (versus spending), not on the specific act of paying off their mortgage. What exactly they do with the money saved isn’t that important compared to saving it in the first place. People just usually don’t announce they bought more shares in a mutual fund.
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Paul says
I believe this is more how we are wired. For the last 20 years every house I have purchased I paid cash for. I never look at opportunity lost and that might be because I still have a lot of CD’s and fund investments as well as I Bonds. I could never have a mortgage again. On another note, you could get a reverse mortgage and use the money for investments. (I wouldn’t do it, just a suggestion). Like I originally said, I really think it has something to do with our brain wiring.
Have a great day!
GD says
Paying off your mortgage? Great! … B U T – NEVER buy a new car! Let someone else pay that first “drive it off the lot “depreciation. Buy a program car, shop diligently, and save thousands on a a one/two year old auto. Also, either CUT UP all credit cards or be responsible enough to pay them off every month ( and actually make 2% on all money spent using the CITI m/c. ) Debt free IS the way to live. Personal finance and fiscal responsibility should be mandatory education in all primary education!
Doug says
I’ve always wondered about the buy used vs new argument for cars. If you change cars based on the mileage instead of age is the depreciation loss offset by keeping the new car longer than the old one?
FinancialDave says
I have nothing against those who want to buy a used car of a few years old, but I have always bought new and drove it until the engine was done or repairs became prohibitive – usually about 15 years. The fact is the last time I went out looking for a new car, I also looked at used cars of a couple years old and the price differential did not warrant the risk. Two main reasons, at least for me were:
1. When you buy used you are typically buying something someone else did not want and there is a risk you will get a car that looks perfectly fine, even to a trained mechanic but it will not be. It will have some intermittent or unforseen problem that you will have to put up with or costly to find and repair.
2. New cars now days come with a pretty good warrantly from the factory, which will generally be about half used up with a 2 year old car. Along with new cars from the dealer also comes the chance for any decent negotiator to bring that price down and close the gap to the 2 year old car, which if being sold by a reputable dealer has to be marked up. In the case of a new car the manufacturer is most likely funding part of the sale in the form of a rebate. By the way I make it a point to never buy cars from the “friend next door” or the little ole lady who kept the car in the garage all these years. Too many things can and do go wrong with these transactions.
What I will say mainly to Harry is NEVER buy a car with a 0% loan and think you got a good deal. What you got was the same thing you get when you buy a “front loaded” mutual fund and we all should know how expensive those are.
What you do is take a lower price on the car (which you can always get if you give up the 0% loan) and let the dealer provide the financing of a 3 year loan with no penalty for early payoff. That is the way I got the absolute best price on my last car. When you get home with the car you then call up the bank and pay off the loan with cash. That is how you buy a car with cash, or you just write the check out right there before you drive it off the lot.
NEVER pay the “upfront load” of a 0% loan and then claim you have an interest free loan. I think we all know better. You have to understand you ARE paying the financing of that loan. In fact many dealers if they are being upfront with you can offer you an extra $500 to $1000 off the price if you take their financing over the 0% loan and that is what you should do.
Dave
Harry Sit says
Dave – Manufacturers used to offer 0% financing OR $xxx cash back. Recently they just offer the discounted financing with no offsetting cash back if you don’t take the financing. Some even offer an extra incentive if you take the financing from their affiliated company, but nothing if you pay cash.
Yan says
Harry,
Thank you for anothe thought-provioking piece. I never thought paying off mortgages in such a way. Your article made me pause and think about some financial decisions we made.
I’m curious why you have credit card debts. Because they are zero interest debts?
Thanks!
MG says
I second this question. I was very surprised to read that you have revolving credit card debt. Can you elaborate more?
Alan apar says
He’s talking about the revolving balance between when you make a transaction and when payment is due for the following statement – in that period you are carrying debt but it doesn’t accrue interest if you pay it in full on time.
Harry Sit says
For simplicity’s sake suppose you charge $10 a day on your credit card. On Day 30 your statement closes. You owe $300. It’s due on Day 50. Between Day 31 and Day 50, you continue to charge $10 a day. When your $300 payment hits on Day 50, your balance drops from $500 to $200. From that point onward, your balance never drops below $200. It goes up to $500, drops to $200, goes up again, … It revolves. Although you don’t pay interest, a 0% interest debt is still a debt.
MG says
That makes more sense!
Scott R says
As always, a fun read Harry. I’m generally against the notion of paying off a mortgage (assuming you have a low fixed rate), and agree with just about everything you wrote. You even stated that it was probably a “net negative” for you.
If you owe $100K on your mortgage and you currently have an extra $100K sitting in a fairly safe place, one big advantage to *not* paying off your mortgage early is that should disaster strike (e.g., losing your primary source of income), you can safely make your mortgage payments *and* all of your other bills for many, many months while you get through that crisis.
I’m assuming that, in your case, you already have a pretty hefty cushion to fall back on, so the $100K (in my example) is just extra gravy, so I can understand paying off the mortgage in that case.
What I can’t understand are people who might have $140K in the bank (just throwing a number out there), and would choose to pay off a $100K mortgage, leaving themselves with a much tighter cushion (emergency fund) to fall back on.
RDE says
I believe Interest received from CDs is taxed as ordinary income. With that in mind the opportunity cost of a 3.0% CD vs the 2.5% mortgage is more of a wash.
Fred Wallace says
Harry,
I’m surprised you would pay off a 2.5% mortgage when you have credit debt at likely 10-20%. This of course makes no sense as one should always pay off the higher interest rate loans first. I currently have a 2.75 fixed mortgage (owe $210,000) and a variable HELOC which is currently at 4.75%. I pay off my credit cards in full each month capturing 2% or more. I will pay off my HELOC if it goes much higher. I will never, however, pay off my fixed 2.75% mortgage as I like the extra liquidity and opportunity to invest this money.
Sincerely,
Fred W
Scott R says
If you read that section of his blog post again, you’ll see that he *does* pay off his credit cards every month. He’s just pointing out that, even if you pay off your credit cards in full, simply using a card as a 30-day interest-free loan, is still partaking in a form of “having debt,” so he’s not technically “debt free.”
Frugal Professor says
Good post.
Kevin says
Great article and thought provoking. The point of an article such as this is that these decisions are rarely a case of black/white or good/bad or right/wrong (on which ever side of the debate one falls). There are nuances to everyone’s individual situation that make a good decision specific to the set of variables they are dealing with. And the part emotions play in all of these situations cannot be understated. One of the things I like about Harry’s articles is the insight into how he himself thinks and that emotions play a large part in decision making (financial in this case but it also applies outside of financial decisions) and recognizing this via introspection and critical thinking is a highly useful skill.
FinancialDave says
Harry,
Great article. I too paid off about a $200k mortgage over the first two years of my retirement and don’t regret it one bit. It’s just one less thing to worry about and the big plus is less cash flow needed to fund retirement, which has improved my ratio of guaranteed income (from SS & pensions) to the amount of money I need to fund from investments. That in itself reduces your retirement risk of not having enough to fund your needs.
Dave
Calmaniac says
To echo Dave’s post: We paid off our house last year. My wife retired this year and I plan to cut back at some point in the next few years. We mainly did it as we did not see much value vs. having the same money socked away in a super-safe investment like CDs. However, as we near retirement, an unintended value is that it greatly simplifies our cash flow situation between pensions/income and spending. Now that the mortgage is out of the equation, the difference between pensions/income and spending is quite modest. As such we have even less to worry about if the market goes south, sequence of returns risk, etc. For that unintended reason alone, I am really happy we paid it off.
• Thanks Harry for another great blog entry!
Avi says
You paid off that mortgage with cash on hand that you could have used to generate ‘guaranteed’ cash flow in exactly the same ratio as now. You are doing exactly what Harry warned against – confusing changing the structure of your net worth with changing your financial position.
Calmaniac says
Avi, I’m not sure I understand your comment “you could have used to generate ‘guaranteed’ cash flow in exactly the same ratio as now”. We had $200,000 left on our mortgage. At a 2% interest rate (CD or bond rate) that will yield me $4,000/year. How is that 2% interest going to generate substantial ‘guaranteed’ cash flow? The monthly payment was ≈$2,400, not including taxes.
Bottom line: I think we’d all agree that there is not a huge plus financially to paying off one’s mortgage. However, it does simplify the cash flow calculus and is one less moving part to worry about. I like to simplify the dumb stuff so I can focus on the important stuff.
Avi says
Calmaniac – You could have withdrawn $2,400 a month from that $200,000, you could even set it up as an automatic payment to the mortgage so it would look just like ‘guaranteed cash flow’. Now that doesn’t mean it would be worth it, but it reduces it to a comparison of interest rate, inflation risk and liquidity risk.
The point is mostly that the apparent cash-flow difference between parking the cash in a CD and slowly withdrawing to pay off the mortgage vs. paying off the mortgage and parking it in home equity is a financial mirage. In and of itself it doesn’t hinder or improve your financial position at all. This is the same type error made when people look at dividends as ‘cash-flow’ and selling equities to raise cash as a distinct type of withdrawal.
John says
Fixed rate mortgage is the best hedge against inflation. Curious if you factored that in when deciding to pay down your mortgage.
FinancialDave says
I don’t see how a mortgage is a hedge agains anything especially not inflation. It is in fact just the opposite. It is a risk that the bank can take away your only place to live which happened to thousands of people during 2008-2010.
Sure you don’t want to take out a variable rate mortgage, that is a given.
Alex says
Hi,
Just my two cents, my understanding is that in periods when inflation is expected (the higher the inflation the bigger impact) a fix rate mortgage will have a favorable impact for the borrower and the opposite for the lender given that such mortgage will be paid (serviced) with dollars with a lower acquisition power (impacted unfavorably by inflation).
Avi says
FinancialDave – Fixed rate debt is a hedge against inflation in the exact same way that fixed rate bonds have inflation risk, it is two sides of the same coin. An easy way to illustrate that is to see what happens when you take out a fixed rate loan and put that money into floating rate bonds…
And no, it definitely isn’t a given that you don’t want to take out a variable rate mortgage – in fact, financially it has been a great choice for the last two decades.
Steveark says
Cannot argue with that logic. We paid our house off early too but mostly just to simplify our cash flow rather than to claim some symbolic victory. I guess there is a little endorphin rush from owning the place but it just isn’t a significant part of our net worth so it doesn’t really matter. I am a proponent of not having more in a house than you could walk away from without hurting your finances. Houses can lose most of their value pretty quickly if your part of town goes downhill so to me they bear the same kind of risk as owning an individual stock. Which means to me that that a house should not represent more than 5 to 10% of your net worth ideally.
Paul says
Avi, I don’t think you are getting the whole picture. What if you don’t need any additional income? My wife and I have been retired 5 years, paid the mortgage at the same time we retired and our net worth is much higher than when we retired. Neither one of us has started SS. When we do start claiming we will have an additional 50,000 a year. We will also have RMDs. It’s not like we are not spending money either. We are getting ready for our 3 Month trip to Hawaii for the winter. Why would I not pay off the mortgage? One less thing to think about. I love simplicity.
Avi says
The only difference in your net worth due to paying off the mortgage will be the interest expense saved minus the returns on the cash forgone.
The reason not to pay the mortgage could be the opportunity cost may be higher than interest expense, the value of maintaining liquidity, the inflation hedge of fixed debt, etc.
If you have no need for additional income, if it doesn’t matter at all whether you optimize your finances than it doesn’t matter one way or the other. Nothing wrong with that, but not really true for most people. As for simplicity, I’ve never really found having another payment draw from my account every month to add measurable complexity to my life – but maybe it was for you.
In any case, it is truly you who isn’t looking at the whole picture but focusing on a narrow piece of it. I’m not saying the pros of paying off may not outweigh the cons for any given individual but I (and Harry in this piece) is definitely taking the broader, more holistic, view of the financial impact of that decision.
FinancialDave says
Avi,
The whole picture really requires that you compare the RISK and the UNKNOWNS of your choices as well. As it turns out the unknows and risks all appear if you DON’T pay off the mortgage and think you are above average at predicting the future. Sure it can work out for you, but then again it may not. What are some risks if it doesn’t – you could be forced out of your house if you can’t pay the mortgage, because you put your mortgage payoff assets in the stock market or some non-insured asset. How do you put a price on that? Most people don’t. Heck for some, having that paid of mortgage literally puts years into their longevity. You can’t put a price on that either. So in fact it is not so much about the math of optimizing your finances as you might think.
Avi says
Yes, the whole picture includes risks – both known and unknown. But it is in fact a financial optimization problem – the math does perfectly well handling risk even if it can’t tell you how much of which risk you are comfortable taking.
The problem is your picture is taking a stunted view of the risk, possibly driven by your own emotional biases of risk, and thus ignores an entire side of it. The trade-off in liquidity when you reduce your cash/bond position to payoff a mortgage brings with it its own set of risks and unknown situation in which you have put yourself in a dangerous position. Sure it can work out for you, but then again it may not – there may come a time in the next two decades when you will wish you had that cash on hand (be it to pay off a ransom, cover emergency surgery abroad or to help your grandkid with that PhD) instead of using it to reduce the ‘complexity’ of one monthly payment. How do you put a price on that?
FinancialDave says
Avi,
You could put a price on it ($0 in fact by opening up a HELOC or other line of credit with zero balance on it.)
In either case it is pretty well known that if people have money sitting around and a crisis comes up (real or perceived) they will just use the money sitting around instead of looking for more options like working out an interest free payment plan with the hospital, or repairing the car instead of buying a new one when it breaks unexpectedly. “Paying for a grandkid’s college” — really that is an emergency!
What you have to remember is debt is “leverage” on your assets. If that amount of leverage is small then it is not a large problem, but it is very similar to buying any investment with leverage such as stocks, bonds, or real estate. It can magnify your gains or magnify your loses. It is just that when that leverage is on your house the result of unforeseen situations can be the loss of your place to live.
Avi says
Dave,
Sorry, but you can’t count on getting an instant HELOC whenever you want – and definitely can’t count on a $0 one (in my state that isn’t even possible because of recording taxes).
Do you have any documentation for that ‘well known’ fact? Do people really have someone replace the light fixtures every time a bulb blows when they happen to have access to cash? Does it apply equally to people who keep it in segregated accounts? Can you think of know other ways to produce the emotional affect of keeping the money aside that doesn’t require giving up its liquidity…
And who said anything about emergencies? You can want liquidity for non-emergencies too…
As for leverage – what you have to remember is that ‘leverage’ isn’t evil in and of itself and is also better modeled financially then through appeals to emotion. In fact, in the situation we were discussing the net leverage isn’t positive anyway… You still are avoiding the whole picture to focus on your narrowly construed fear of losing your home – what about the scenario where your home is destroyed in a way not covered by insurance, the person who paid off his mortgage has nothing left and the one who kept the mortgage and his liquid cash can afford to find a new place to live – the result of that unforeseen situation for the one paying off the mortgage can be the loss of their place to live..
FinancialDave says
Avi,
Personally, I have never had any fear of losing my home, for me it was just about decreasing my cash flow need in retirement. I just spent a lot of time reading about and seeing people who did lose their home in the last recession because they were essentially over-leveraged or liquidity they did have suddenly evaporated after losing their income for a year or more.
As far as the belief that your mortgage is going to be forgiven because your house was destroyed – well that usually only happens if you have NO liquidity and are bankrupt.
If your plan is just to walk away from your obligation then I guess there is nothing more to talk about.
Avi says
Dave – And there it is again, confusing ‘cash flow need’ with financial well being. That need was just an emotional mirage – moving the cash from one part of the balance sheet to another didn’t really impact your relevant income needs in any way, even if it made you feel better about it. Just another reflection of not looking at the whole picture.
And as for giving the collateral to the lender – that isn’t walking away from your obligation, that is fulfilling it. It is part of the risk they assume and is built into the rates they charge, you don’t owe them any special favors because that risk materialized – at least when you are taking a financially rational approach to financial decision making.
Paul says
Avi, I am looking at the whole picture, you aren’t. Why would I want every dollar I spend on a mortgage to save me 28 cents in tax returns?
Avi says
Paul – this isn’t intended as a personal slight or anything, but no you aren’t. You are focused on a narrow sliver – the financial value one way or the other doesn’t matter to you and you find it simpler. You aren’t looking at the whole picture which would include looking at the financial value of the decision (including opportunity cost, liquidity risk, etc.)
It has nothing (well almost nothing) to do with tax deduction of mortgage interest, the easiest way to integrate that is to use tax-adjusted interest rates when comparing opportunity cost and interest expense.
To answer your question, you’d want every dollar you spend to save you 28 cents because it is better than it saving you zero cents. Whether it will depends on your personal tax situation.
Paul says
I am just going to have to agree to disagree. Over and out with reply’s no longer notifying me. I am happy and so are you.
shawn says
You paid off $197,000 in mortgage but complain about having debt still? How can you not tackle those ? Wow you’re an idiot.
Scott R says
Try reading the blog post again, and this time make notes regarding 0% loans and revolving debt.
deez nuttz says
So basically this is an article about you not still complaining after paying off a mortgage which is exciting in of itself but you still wanna find things to complain about. Real simple get rid of your other debts. What a waste of time article get off the internet.
Somebody in GNV says
Just how hard is it for some people to understand that revolving debt is still debt, even if you pay it off every month and never pay interest? There is, on average, always some level of debt involved.
That’s not evil. It’s just describing the financial arrangement accurately. Those posting negative comments about paying off a low rate mortgage before paying off “high cost” consumer debt draw knee-jerk conclusions before reading what was actually written, or they don’t understand what they read.
Personally, I’m at retirement but have no plans to pay off our 15 year mortgage @ 2.9%. Paying it off would require withdrawals from tax-deferred accounts, triggering ordinary income tax and pushing me into a higher tax bracket. For what benefit?
Besides which, I’d lose my inflation hedge. Yes, inflation is low now, but who can tell what the future will bring? (I remember Paul Volcker’s term as Chairman of the Fed.) If it stays low, the cost of the inflation insurance is nominal.