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 average … they 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 😉