Name one investment that is as secure paying off your mortgage

I wrote a highly controversial post a while ago about how dumb it really is to pay off your mortgage – especially if you have a goal of getting wealthy (which is the whole point of this blog).

Others, like Ric Edelman and a whole bunch of other ‘Dave Ramsey / Suze Orman Busters’ agree … in fact, when Todd Ballenger’s team saw my posts on this subject they sent me a copy of his new book, Borrow Smart Retire Rich, to review (I am reading it as I write this).

He makes the point very clearly, articulately and forcefully: sometime is Ok t pay off your mortgage, but ot if you want to accelerate your wealth.

However, not everybody agrees; Wealthy Reader wrote a whole post refuting my own post. The arguments basically boil down to these:

Real estate has appreciated at about 3.8% a year historically (excluding the bubble). This is also about the rate of inflation. So unless you are in a hot real estate market, there is no upside.

According to Todd Ballenger in Borrow Smart Rich “since 1945, the median house price in the United States has risen by an average 6.23% per year”. I used 6% in my post comparing R/E to your 401k.

But, would you settle for just average appreciation potential when buying an investment property (remember, we are talking about buying an investment instead of ‘investing’ that money into your own mortgage by paying it down early).

If the average appreciation is truly 6.23%, I could do better than that with my eyes shut … I would just tell a Realtor to buy me anything near the water or in a yuppie area in any major US city – as long as I was prepared to hold it for long enough.

[AJC: Yes, any discussion of RE today says: “well Florida boomed, now look what’s happening!” … yet if you look at quality Florida real-estate over a 20 or 30 year period, you’ll achieve average growth far in excess of the nation’s averagethey simply don’t make any more ocean-front land … even my 13 y.o. son knows that. He tells me that land on the lakes in Wisconsin sell for many times higher prices than the land even one block in: one has a rare commodity – access to put your boat in/out of the water – and the other doesn’t!]

If that’s too risky, I would just avoid buying anything in the dust bowls of the US countryside, or in any of the run down ghettos in most major cities – these properties are also included in the average growth rates.

[AJC: Yes, people will say: “But look at Harlem … it was a ghetto, now it’s booming”; this is true of SOME of the dust bowls and run-down ghettos some of the time … if you want to have a better-than-average chance of finding the next ghetto-turned-to-gold find the area/s where the artist colony is … invest there and wait 10 years. You’ll be sitting on gold!  Again, do you think the returns might beat the 6.23% average?]

The bottom line: you should have no fear of meeting or beating 6%+ returns in well-chosen real-estate over a 10 – 20 year period.

The interest is compounding so you don’t just pay 8%. That’s why you pay so much interest over the life of the loan. That 8% is compounding each month (at .6%) on the entire balance. So again there is no convincing argument.

Well, hang on a minute, by paying down your 6% – 8% mortgage to avoid the compounding nature of loans, aren’t you simply avoiding putting your money into another form of investment where the increase will also compound?

I mean, we aren’t planning to spend all that extra money that we could be putting into our mortgages into drinking more beer and eating pizza (yet)!

A simple example would be to put that money into a low-cost Index Fund; don’t they appreciate at over 11% annually – and, at no less than 8% (break-even) – over a 30 year period. And, didn’t I write a whole post showing that investing in real-estate could do even better?

The majority of tax payers either can’t or choose not to itemize.   According to the Urban Institute, only 35% itemized in 2004. Also, there are limitations on deductions.  So the famed mortgage interest tax deduction is mostly irrelevant here.

One Wealthy Reader reader (!), Jeff, jumped on this one saying:

Although trivialized by this blog, the mortgage interest tax deduction is a substantial benefit received by millions of Americans each year. You appear to argue since only 35% of Americans itemized their deduction, that this tax benefit should be completely discounted. This statistic, however, is not persuasive and it provides no insight into the number of homeowners that have mortgages that cannot or do not take advantage of this tax break.

But, if you truly feel that there is no tax-advantage to the 8% claimed benefit of either keeping or paying down the mortgage, what about the 25% – 35% tax-advantage that you would get by ‘investing’ that money instead into a tax-advantaged account such as a 401k?

Or, what about using it instead to fund a fully tax-deductible loan on an investment property (preferably one with depreciation benefits and/or good rental returns as well)?

Finally, Wealthy Reader throws in his ‘trump card’:

There is no investment that is as secure as a paid off mortgage and that also returns 8-12%.

How the hell is a paid off mortgage secure?

Is it because your money is now invested in your house? If so, how is it any less secure if some of it is in your house and some more of it is in the house next door and the one next door to that one?

Is it because the bank can’t touch you once it is all paid off?

Well, if that takes you 15 years to accomplish that (instead of the usual 30 years), what will the bank do if you lose your job and can’t keep up with the house payments in Year 12?

Guess what, they will still foreclose on you whether your equity is 20% or 40% or 60% or even 80%.

Surely the only thing that matters here is investment risk and investment return, after tax?

Like everything else, just run the numbers through a spreadsheet, it doesn’t take a rocket scientist to see that an 8% return is not as good as a 12% return (both must be on the same pre-/post-tax basis) …

… and, if you really can’t find an investment that will safely return 12% over 30 years, I agree: go ahead and pay off your mortgage, because you sure ain’t no investor 😉

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8 thoughts on “Name one investment that is as secure paying off your mortgage

  1. I find the whole discussion of putting your in your mortgage vs. the stock market sooooo tired. If you pick up magazines on finance, there are endless articles on “should you put money in your mortgage or should you put money in the stock market”. The artciles then go on about how you can make 8% pa on your house and 11% pa on stocks. blah blah blah.

    These articles just dont get it. Furthermore having this argument is the wrong argument. You should be looking for a range of opportunities to make a 100% pa or more not 10% pa. Once you have found a relatively good one, you pounce make your money, get out and start looking for the next opportunity. Once you have made your dough you can then decide what to do with it. You can decide to pay out your mortgage or top up your kids college fund or you can put it in a slower passive money making thing like rentals / 401K / super or you can invest it in the next big thing. Generally it is better to 2 or more of the 4 options depending on how much you have made, because you dont know if your next venture is going to be a doozy. In my case I used realestate speculation to pay out my mortgage and with the left over cash I am now looking for the next thing.

  2. Actually mortgage interest does not compound, at least not in the sense of compounding interest. When you get a rate of return on an asset the next year you gain on the asset plus the additional gain from the positive rate of return. This getting interest on last years interest is what compounding means. In a mortgage you pay interest on the principal amount each year, so unless you are in a negative amortization loan your interest will either stay the same (interest only) or go down the following year making your interest payment smaller. That is another reason why it makes financial sense to re-finance after 10 years. The amount of interest paid is significantly lower in year 10 lowering your tax benefit. Finally, I love the fact I am paying off a loan with devalued dollars. The dollars I pay in 2008 are worth much more than the dollars I will be paying in 2018!

    I have found that these folks that hate this strategy are reacting to the emotion of fear or scarcity. It is really pretty simple to set up a chart demonstrating the advantages of even getting the same rate of return as your mortgage rate. Of course the advantage of this arbitrage increases dramatically with every 1/4 point you do better than your mortgage rate!

    If you can’t get 7-8% on your money then that is the real problem, not the simple mortgage arbitrage!

  3. The post by Shafer Financial is what I have been thinking about for some time as a first time home buyer.

    From what I have been able to understand myself if you put a dollar on principle on the first payment that dollar saves you a heck of a lot more than the extra dollar on principle halfway through the loan repayment period and no savings on the final payment.

    With that said, there must be a formula indicating the amount of savings for each amount on principle for each payment in the amortization schedule. What would that be?

    THAT would be helpful.

  4. @ Caprica – Me too; I’ll have to stop talking about it 😉 The pay-down-your-morgage guys miss the point: they are REDUCING levergage, when they should be INCREASING it … at least, if they want to BUILD REAL WEALTH.

    There MAY be a different discussion if you are in Making Money 301 (a.k.a. ‘retirement’) and just want to preserve wealth. Even then, I would be leveraging into RE – just at a lesser Loan-to-Value Ratio.

    BUT … the remainder of your comment is about SPECULATION, which really isn’t necessary unless you have a VERY financial mountain to climb and yoy are willing to go the ‘Summit or Bust’ route many times!

    @ Shafer – No, mortgage interest is indeed flat … except if you have a P&I loan that recalc’s on current loan value and don’t reduce payments to match reduction in principal … then you are effectively getting a ‘compounding’ reduction in ‘whole life cost of the mortgage + principal’. I think 🙂

    You make a strong argument for fixing the interest: inflation is suddenly on YOUR side. The ultimate anti-inflationary too, by corollary, is not to pay ANY principal for as long as possible!

    @ Ben – there are online mortgage calculators that will show the effect of prepayment of principal, but to do so misses the point: from an investment perspective there is no advantage to take your capital OUT of circulation, when it could be used so much more effectively elsewhere (e.g. buy an investment property; start a business; heck, buy some stocks).

  5. Whether paying off your mortgage is the right move depends on your objectives. In wealth creation mode, it should be possible to identify investments which produce better returns than the savings in mortgage interest. If you take this line of reasoning to its logical conclusion you would always opt for interest only loans (assuming the interest rate is the same) and only repay when the asset is sold. Alternatively, if you are in wealth preservation mode, a lower return, lower risk investment such as paying off a mortgage can make a lot of sense.

    Of course, if you are clueless about investments I would advocate going for the investment everytime – its the best way to educate yourself. In contrast, if you have doubts about your ability to service the mortgage in the near future repayment may also be the right move.

  6. Pingback: At last a post that agrees with me! « How to Make 7 Million in 7 Years™

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