Should I Pay My Mortgage Early?

Most people don’t like debt hanging over their head and a feeling of security comes from the idea they would own their house outright.

We get people coming to us regularly who are making extra payments on their mortgage in order to extinguish their loan early. But by paying in advance you’re highly likely to have a lower amount of wealth, and thus standard of living later on, by doing so. Lowering your total lifetime wealth also increases your chances of running out of money in retirement and thus needing to sell the house you paid early to own, or needing to borrow on it again in retirement with a reverse or conventional mortgage.

Interest on a mortgage is, for most people, at least partially subsidized by a break on your taxes (amount of deductible interest on the mortgage on your residence has been reduced to interest paid on a maximum of $750k loan value according to the new tax law).

If the interest rate on your loan is 4% and 20% of that is subsided by a break on your taxes the simple effective rate is thus 3.2%. The S&P 500 has returned an average of over 10% over the last 80 years, 8.88% over the last 10 years and 9.65% over the last 15 years (other baskets of stocks have done much better).

Let’s say I get a 4% $650,000 30 year fixed mortgage today and I’ve got 20 years until I retire. My principal and interest payment is $3,103 and in the first year I would pay $19,387 in interest, decreasing every month/year as I slowly extinguish the debt (tax break reduces over time). If you’ve never looked at how a mortgage amortizes it can easily be seen/found doing an internet search by typing “mortgage amortization calculator.”

Let’s say I pay an extra $1,000 in principal/month instead of making the minimum payment. Instead of 30 years I will have paid my mortgage off in 19 and will save $191k in interest payments to the bank.

However, let’s say I invested the $1,000/month and it returned an average of 8%/year over 19 years, my pool of additional wealth would then be $639,000 and I would still owe $335k on my mortgage.

I could do a partial liquidation of the portfolio to then extinguish my mortgage, and pay a lot of capital gains tax to do so (I’ll also pay more tax along the way for having additional wealth), and I’d still have a big pile of wealth (maybe $240k after tax) I wouldn’t have had by making the extra $1,000 payment per month for 19 years!

I could also simply accept that I will have mortgage payment through some of my retirement and let the total extra wealth pool grow, or use some on a monthly basis to have a higher standard of living or cover the mortgage payment, and my lifetime wealth will be radically higher by doing so.

If I wind up living longer than average I want to have as much money at my disposal as possible to keep living a good life, or cover expenses for my care or health costs.

We want to do what feels safe but this is often counter to what’s in our best interests. Proofs of these counter-choices can be found in the works of Nobel Laureates Daniel Kahneman and Richard Thaler (and others).

It’s sometimes hard to make the best decisions for ourselves without the context and perspective for doing so in which case it’s okay to get the help from an expert sworn to put your interests first before their own. Planning ahead with the help of an expert may radically increase your odds of maintaining your standard of living no matter how long you live.