Contrary to popular opinion, paying off your mortgage is the dumbest move you can make …

I wrote a post a long while ago … actually, it was my 5th-ever post – some say that I should have stopped there 😉 – about the classic Rent or Buy dilemma for your own home … and, I just (!) received an interesting comment to that Post from Joy:

That’s the silliest thing I’ve ever heard – borrow against your house (aquire more debt) to invest??? Paying off your house early and being debt-free allows you to do whatever you want with your income, THAT’s truly the way to wealth.

Now, Joy is not alone: I recently read a post by Boston Gal on her blog that talks about Suze Orman’s  advice which also is to pay off your home loan early:

Believe me, I have thought about trying to pay off my mortgage early. But since I have an investment condo which is mortgage free (yeah! paid that one off in 2007) I have been a bit hesitant to use my current excess cash to pay extra toward my primary home’s principal.

 Now, this sparked a whole series of comments, including this comment from ‘Chris in Boston’ who said:

This is interesting. Usually you hear from personal finance people that its best to take on the longest fixed rate mortgage you can afford. This allows you to tie up as little cash in a non liquid asset as possible (slowly building equity). Also allows you to protect that pile of cash from the effects of inflation. The house is bought in today’s dollars and paid off over 30 years in today’s dollars.

Sure, when you own a property you have to compare it to owning any other investment – cost/benefit; risk/reward; all the usual stuff. You also need to compare the costs of holding it (including interest) against the costs of investing elsewhere.

But, this last piece in Chris’ comment is THE critical point: “the house is bought in today’s dollars and paid off over 30 years in today’s dollars”.

You see, the one thing that makes owing a property, even your own home, very different to any other investment is that it can be easily financed … almost completely (remember the sub-prime crisis?).

This leads to a whole swag of benefits that I don’t think that you can get anywhere else … benefits that simply cannot be ignored by the typical saver / investor.

Here’s why …

When you mortgage a house, you and the bank enter into a partnership (typically the bank is an 80% partner and you are a 20% partner going in), but you are not in the same position:

1. You have access to ALL of the upside … so as inflation and market conditions push the value of the property upward over time, you gain 100% of the increase, the bank gets none of it.

Let’s say you buy a property for $100,000 today; you put in $20,000 deposit and the bank puts in $80,000 as an interest-only loan (forget closing costs for now) … in 20 years, if it doubles to $200,000, your share of the ‘partnership’ is now $120,000 and the bank’s is still $80,000.

You are now 60/40 majority owner of the real-estate venture! In fact, even as 20% ‘owner’ you have total control over all the decisions related to the real-estate – as long as you pay the bank on time.

2. Sure you pay the bank interest on their $80,000 share … but this is fixed (you did take out a fixed interest rate, didn’t you?!).

At 8% interest rate that’s approximately $6,400 per year … this year.

Why only this year? Because the same inflation that is increasing the value of the house (and you get to keep 100% of that increase) also decreases the effective amount that you pay to the bank; as each year goes by, the bank gets less and less in real dollars and your salary goes up.

The price of bread, milk and gas may go up, but the bank’s interest rate never will because it’s fixed!

3. You either get 100% of the value for the payments that you make to the bank (call it ‘rent avoidance’ if you live in the property) or you take 100% of the income if you decide to rent it out … all as 20% minority ‘partner’ going in. The bank on the other hand, gets their $6,400 and ONLY their $6,400.

4. The government gives you tax breaks and incentives to do all of this!

Here is my advice …

Look at everything that you own as a business: if it’s your own home, separate the ownership of the property in your mind from it’s use …

… for example, even if it’s your own home, treat yourself as your own tenant and figure the rent that you would otherwise had to pay when doing the sums.

Then evaluate the investment against any other investment or ‘business’ … and ask yourself:

– What ‘business’ gives you pretty damn close to 100% control for only 20% initial investment?

– What ‘business’ lets you in for only 20% initial investment, but then gives you all of the upside?

– What ‘business’ gives you only one-time multiplier on your initial investment on the downside but a five-time multiplier on the upside?

– What ‘business’ grows in your favor (and not your “partner’s” favor) merely by the effects of inflation?

By all means, pay off you mortgage and your lines of credit as you reach your financial goals and are set to retire …. you have plenty of money and just don’t need the stress, right?

But, if you’re still trying to get rich(er) quick(er)?

If you own a home, don’t pay it off … use the upside to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ‘businesses’ …

If you have other sources of income (businesses, investments) don’t spend it or reinvest all of it … use some of the spare cash to help you buy more and more of these wonderful, one-of-a-kind, almost-too-good-to-be-true ‘businesses’ …

That’s my advice to you, and to Joy, but only take it if you want to be rich!

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72 thoughts on “Contrary to popular opinion, paying off your mortgage is the dumbest move you can make …

  1. Yeah, I see how your math is supposed to work, but I still don’t get what makes you think you are guaranteed to get a return that outpaces paying off the interest on you 6% mortgage.

    Lets say you could do something impossible, like take $1 and use it to borrow a million dollars, at 6% interest. Ok great, you really have some great leverage potential.

    Now, what if you don’t turn a profit.. or one that outpaces that 6% you need to pay back? You only have 1$ worth of assets/equity.

    If you assume (for the sake of mathematics) that you will consistently make good returns with your cash, your math works out great. But if it doesn’t, the more you are leveraged the bigger whole you are in.

    Do you not agree? Hypothetically, if your investments are in the black, what happens here?

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  3. AJC – During the last few years, I’ve been focusing on growth more than earnings and at the moment I find myself in a tight position.

    I share your view in terms of inflation eating out mortgage repayments over time, that’s my position for the property we live in. However, here in England it is not that easy to get a long term fix-rate mortgage, and with the shake-ups of the LIBOR we are seeing (and banks not passing on rate cuts), all of my investment properties are panning out massive monthly payment increases (20-30%).

    I think that in the US they call them Adjustable Rate Mortgages (ARM), and they is the norm over here.

    No matter how hot is getting (and my Spanish investment property just went up an extra 16%), and how comfortable I feel, time ticks in our favour and, after resetting, the rent of one of the ‘growth’ properties is covering the mortgage payments. For now.

  4. @ Calvin – I think what yo are saying is that interest rates are spiking, but capital appreciation and rents have gone up, too … so, for now, you are OK? Look around for fixed rate mortgages or bank bills or some other instrument: they exist in the UK (a similar situation exists in Aus) – so find them and see if they can be made to work for you … just another variable taken out of the equation so you can sleep a little better at night. The only other ‘safe’ choice is to sell down part of your portfolio and reduce the debt component of the balance (i.e. this is called de-leveraging your portfolio: a Making Money 301 ‘wealth protection’ strategy).

  5. Hello,I am not very money smart, I would like to see on paper something to pursuade me to not pay my mortgage off,, I am 3 years into it, I am paying 6 1/2 percent int., at this point it is over 10,000 a year in int.. Why wouldnt I be better paying off my mortgage and putting the 10,000 I was paying the bank into an account that would pay me int. instead? I am asking this because I do not know,, thanks

  6. @ Tryin 2 Get Ahead – It’s actually a great question with a very simple answer: by paying down your mortgage you are saving 6 1/2% interest; money saved is money earned …

    … so, by paying down your mortgage you are really ‘earning’ 6 1/2% interest.

    If putting your money in the bank will earn you only 4 1/2% interest, then you should pay down your mortgage.

    However, if you can earn 12% on your money by putting your money into, say, an Index Fund, then you should do that instead.

    Just put your money where you can get the highest return that YOU are comfortable with … simple!

  7. Thanks for the help, on the other side of the coin,,, to keep cash availible in a very uncertian economy, I would not mind doing a refi. on my house because the rate at my bank is 5 1/2 right now and thaaat would drop me over a point from where I am now I feel like if the economy got real bad I would have cash to spend , instead of a debt free mortgage that I couldnt buy groceries with, know what I mean,,,,,, also if the economy gets worse it may be to mt advantage to wait to refinance, because chances are rates will go below 5 1/2 possibly in the next year. Get a low rate but still keep the tax advantage of mortgage int. What is your thoughts on this? thanks

  8. @ Tryin – You are right, a paid off house won’t put food on your table (directly). If you do refi (just check the refi costs against the interest rate savings) I suggest that you lock in the rate for as long as possible.

  9. Not sure I agree, unless I’m just not getting it… My house, as much as I’d like to consider it an asset, is really a liability. It’s constantly costing me money! So, I can’t look at it as a business since the goal of any business should be to produce income.

    Are you suggesting we should borrow money to start and/or purchase a business that produces zero income?

    Also, if I keep my mortgage to term, I end up paying 2-3 times more (with interest) than I actually borrowed (ie. than the house is worth).

    And as far as the government tax incentive… If I’m in a 26% tax bracket, I pay $1 in mortgage interest just to save .26 cents on my taxes. Again, that’s nice while I’m still trying to pay off the mortgage, but I’d rather get it paid off as fast as possible, keep the other .74 cents in my pocket, and be secure knowing I can’t be kicked out if I don’t make the payment.

    Hey, if this sounds like a good deal to you, go ahead and send me all your money, and I’ll send you back 26% of it in return! 🙂

    Incidentally, regarding point #1… If you don’t make your payments, and the bank takes back the house, they DO benefit from the increase in property value — since they own the house, of course.


  10. @ Dave M – You say potAYto, I say potAHto … that’s what makes the world go around 🙂

    If your house isn’t an asset (and, I agree, it’s a pretty poor one … it will probably fail this test: then does it make sense to plow your ‘free cash’ into it rather than into higher returning investments?

    BTW: Try missing your 99th payment and see if having the majority of the equity in your hands rather than the banks saves you from foreclosure 😉

  11. This is ridiculous. The author apparently believes he is untouchable and will never lose his job, get sick, or die.

    You can do all the complex math you want, but the simple fact of the matter is that Risk is the biggest variable, and I don’t see it show up in your equation once.

    Don’t be stupid America, and dont prescribe to a system that encourages you to continue owing people money long after you need to.

    Pay off your house, free up some income, then pay off your credit cards, pay off your car, and be a happier, less stressed individual.

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  14. Adrian,

    Although a riskier choice (depends on your definition of risk I suppose) this is something most wealthy people I know do. Especially with incredibly low interest rates (4-5%), it’s hard not to beat that small of an interest rate.

    Been through this same argument with friends before and a lot of people just can’t seem to wrap their heads around it. Mostly because popular culture says… get a job… buy a house… pay off the house… retire… die!


  15. @ Eddie – I didn’t say NOT to pay off your house; mine is worth $6 million and I don’t owe a dime. Read the article again … 🙂

  16. As a woman, I just want to say that “to each it’s own” Women love security.

    If you are not a person that love investing, and you have the cash to pay off your mortgage (considering that you plan to live their forever)

    Adrian- not everyone is business oriented. Some just don’t have the business acumen to run a business. Therefore, that group SHOULD pay off the mortgage

  17. @ MoneyMonk – Paying off your mortgage is a ‘guaranteed’ (say) 5% after tax return on your money … if that’s all you need/want to earn, go right ahead 🙂

    But, you don’t need a business (or even much acumen) to beat 5% (give or take a % or two) over a 15 to 30 year period … simply buying/holding a few quality stocks, or buying some good quality rental RE, or [etc.] will KILL that rate of return.

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  19. “But, if you’re still trying to get rich(er) quick(er)?

    If you own a home, don’t pay it off ”

    Um… Biggest warning sign in investment history here :o)

    “Get Rich Quick” = Run. Far, far, away.

  20. @ NoShortcuts – The time to buy is when prices are low. You can’t buy investments if you’re busy ploughing all of your cash into your own home.

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