Should you pay off the house?

An increasing number of homeowners are considering paying off their mortgage early.  While paying off debt generally is a sound strategy, homeowners also are aware that mortgage interest is tax-deductible, so paying off a mortgage early may not be in the best interest for all homeowners.

MAKING SENSE OF THE STORY 

  • Homeowners with credit card debt, and those who aren't contributing the maximum amount to a 401(k), are advised to make those the first priority.  It is also important that homeowners have at least six months' worth of living expenses in cash.
  • Retirees, and those close to retirement, who are contemplating a lump-sum payoff, need to ensure they have enough liquid savings to handle emergencies and unexpected medical expenses.
  • Homeowners planning to move to a larger home or downsize to a smaller one within five years are not advised to put extra money toward a mortgage.
  • For many retirees, and those nearing retirement, who are close to the end of the mortgage, the interest deduction may not be considerable enough to avoid paying off the loan, especially since retirees often end up in a lower tax bracket.

clear skies,

Doug Reynolds

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February 25 2011 - Sacramento
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Profile picture for sunnyview
CNN money also has more about this topic in an article here.
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February 25 2011
Profile picture for the_country_hick
Paying off the highest interest debt first makes sense.

Not paying off a mortgage because you would lose 1/3 (in the highest tax bracket) of every $1 you spend is foolish. I would prefer to keep more than 66 cents of every dollar. I would prefer to keep $1 of every $1.
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February 25 2011

Ric Edelman, America's #1 independent financial advisor 09' & 10' (Barron's magazine), inductee into the Financial Advisor Hall of Fame, #1 selling author, amongst many other honors/awards, made a big commotion in the mortgage world a few years ago with his blog post: 10 Great Reasons to Carry a Big Long Mortgage. Never own your home outright. Instead, get a big 30-year mortgage, and never pay it off — regardless of your age and income.
 

When I first read it I was thought he was just trying to get people to read it with a controversial headline, or just crazy, until I did the math myself. Ric is 100% right. There is really never a reason to pay off the house, get a 15 year loan, or even make extra principal payments towards the mortgage; and it can be counterproductive to actually achieving our goals.
 

Here's his article (it's been updated a few times over the years). http://www.ricedelman.com/cs/education/article?articleId=232
 

Since that revelation I've changed the way I council my clients. Most people are not receptive to the truth at first, and some never want to hear it, but for those that do they had the right information to make the best possible decisions with their mortgage and are in a better place for it now.
 

~ Greg

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February 25 2011
Profile picture for the_country_hick
Greg, that article makes many assumptions. One is that house prices always go up. Another is that you get 8% interest. Show me where you do that now. In fact following that kind of advice is what got many people foreclosed out of houses they had that were paid off. When someone has owned a house for over 20 years with negative equity that program is what caused it.

Many people took money from their house. hey put it into the stock market. Both lost value and now they do not have a paid for house and a big mortgage besides.
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February 25 2011
Profile picture for shasta_steve
Greg that was the exact same advice I was hearing from a loan officer a few years ago at my buddies coffee shop.  He was always saying it was stupid to pay off your mortgage, or pay down the note, and you should refi whenever you got equity.  The good thing is lost everything when the market turned, the bad thing was so did many of his clients.   If you go that route you really are gambling with your future. 

I have no doubt that for many high income people it may be a good strategy but for many of us average Joe's it does not work so well.  When people have extra money they tend to spend it and not invest it.  I come from solidly blue collar people.  The biggest thing I have  seen, for most people, is having their house paid off when they retire is usually the difference between having  decent retirement and a bad one.  

Now one thing I do agree with is you should fully fund your retirement.  Whenever we hire younger guys at my work one of the first speeches I give is the 401K one.  I am always amazed how few people put into the system, especially because the company will put in 5% if we put in 7%. 
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February 25 2011
Good points, Doug.  But you also want to consider the fact that we reach a point where the standard deduction is worth more than the itemized deductions when the loan gets paid down to that point.

Also, if you're in, say, a 15% to 20% (state + fed) marginal tax bracket, does it really make a lot of sense to keep paying mortgage interest when every $1,000 you pay only reduces your taxes by $150 to $200?

And what if the interest deduction is eventuallly taken away?

My observation is that behind every bit of advice against paying off your house is someone who stands to make money on what he wants you to do with the money that would otherwise be used to pay off the house.
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February 25 2011

Steve,

First thing, I never advocate that someone refi any and every time they have equity. Each person's situation is going to be different and should be looked at as such. I like to sit down with the borrower and his/her financial planner when they make that decision to make sure they are doing the right thing and have a solid plan with achievable goals.

So, now that we have that cleared up. No one lost anything when the market turned for NOT paying extra towards principal. Just like Ric explains the only way to get at your equity is to sell or refinance. Well, when the market turned that would be the worst time to try and do either of those, something that would be impossible to do for a lot of people and just so happens to the be the time most people needed to do it. You're making my point for me. Now this loan officer you speak of may have given bad advice, I have no idea, however if all he said was not to pay down your mortgage any faster than you have to what did any of these homeowner's lose when the market turned? If they followed his advice all they lost was risk, which was left with the bank.

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February 25 2011

(continued)

Also, in times like these, after the market turned, a lot of people lost their jobs/income. Cashflow is more important now than it ever has been. Say you're 5 years into a 15 year loan that you've been trying to pay off as quickly as you can. You're budget allows an extra $100 towards the principal on top of your payment and, oops, down economy's here and you lost your job. Well your mortgage balance is significantly lower than it would have been if you had gotten a 30 year loan and never paid any extra to the principal but now you have no money saved and no income! A lot of good that lower balance is now, you're about to lose your house anyways (that 15 year payment is a lot harder to make with no income than the lower 30 year payment would be). And, since this is happening while homes are at their lowest value in 8 years, you're taking a big loss too. Now you've lost your house and all that extra money you put into the mortgage, and have nothing. While your neighbor got a 30 year loan 5 years ago, he lost his job too (you worked at the same place). But he put the difference of the amount between what you put into your mortgage, and his 30 year payment, into low/moderate risk investments. His mortgage balance is quite a bit higher than yours but he has enough extra saved to make his mortgage payment for another 4 years if he had to.

You're right, having your house paid off at retirement is usually the difference between a nice retirement and a bad one, except you have it backwards. Most people that retire with their home paid off have much less wealth and income than they would have otherwise had. Someone that wisely saves/invests will always have a more comfortable retirement compared to the person that puts that extra money into their mortgage just to have the house paid off. A LOT of those people retire with nothing.

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February 25 2011

(continued)

I don't know about you but I'd rather have (I'm just making these numbers up) a $1,000 mortgage payment with a $3,000 monthly income and $300,000 in the bank/retirement accounts than $0 mortgage payment and a $1,000 a month income and little to nothing in the bank. While the differences don't have to be that dramatic, they usually are. I see it all the time. My retired clients with a free and clear property or that almost have their home paid off have little to nothing for savings/income, they put it all into the house. A lot of them are looking for reverse mortgages (products I don't like if they can be avoided) just to be able to have any sort of dignified lifestyle. While my clients at or near retirement that have money in the bank and a more certain retirement in front of them almost always have a mortgage, usually one that wasn't originated all that long ago. They can make their mortgage payment and have plenty in monthly cash flow and reserves. Heck, a lot of them have enough to pay the mortgage off in full. But they don't, because they are smart.

Of course there are some variables. In a down economy like this one some people may not be able to sell when they might have wanted. Some people may decide to work an extra year or two before retiring. But you know what? Those decisions would be no different if they put money into their mortgage instead of saving/investing it over the years. The difference is the person with the smaller loan will be less wealthy and have a smaller monthly cash flow. Every time. It's the "Smart Sam" & "Nervous Nick" thing.

~Greg

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February 25 2011
Doug,

Great points.

Also consider the opportunity cost of tying up your money by paying off the loan.  If you can earn more than the interest cost with the money you would use to pay off the loan, do not pay it off early.

Your Real Estate Geek,

 Rich
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February 25 2011
Profile picture for the_country_hick
Greg, make a few assumptions.

1 a person buy a house with a 15 year mortgage at age 25. They pay it off by age 40.

2 that person did not place themselves in a tight financial situation so they could actually afford to live. In fact they even saved some money just in case.

3. that same person who spent their money on their house now at age 40 has another 25 years until retirement with no rental costs except for taxes, insurance, and maintenance.

4 that person now at age 40 saves heavily for retirement placing all of their house money not into rent or a monthly payment but into savings.

Explain how them paying more in interest costs than they can get from interest on their money gets ahead.

Some people never save a dime. It does not matter if they make $5,000 a year or $500,000 a year. They can blow everything on nothing. For them buying a house at least gives them one asset they can call their own in time. If they have nothing else for retirement it is their own fault. They never think ahead or plan for anything. Giving that type of person a home equity loan is likely going to help them lose their house. It is far more likely they will blow the money and not invest it. If they do invest it expect the investment to blow up and disappear.
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February 25 2011
Profile picture for Pasadenan
Very rarely can you invest money at a higher interest rate than you are paying, even after adjusting for any tax benefit (if there even is one).  And even for people that do, that investment sometimes goes "bad" causing one to have major losses.

There is no better "security" than knowing that regardless of loss of job or health or anything else, that there is no housing payment to be made!

Besides, once it is paid off, all the money that would have gone to mortgage is free to invest as one chooses, which is "great" for those that really know they can get that 10% to 30% annual return on their investment!

Yes, Realtors® are taught from day one that "leveraging" is the best thing ever invented, and that it will make you a fortune with other people's money; but that is only in a rising market.  In a falling market, leveraging bankrupts people instead.

There is no reason to gamble on your home.  Pay it off!  Your bank is only paying you about 1% interest to deposit it there, so why not deposit it into your house and get about 6% return?  Even after the tax deduction, that is still at least a 4% return which is 4 TIMES what the bank will pay!
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February 25 2011
Dan,

Take a short course on Compound Interest 101 and then ask me again. The person that pays off their house in half the time, assuming they never have a loss of income along the way and are able to keep the house the entire time, will still end up with less wealth and MUCH less financial security at the end of 15, 20, 30+ years.
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February 26 2011
P.S. Do you people realize how many seniors end up with their homes free and clear but can't even afford the basic necessities of life? And how many of those seniors end up losing their home because they can't even pay the property taxes every year? This is a real problem that happens more than you realize.
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February 26 2011
Profile picture for the_country_hick
Greg, I do understand compound interest. I also know that compound interest that is accumulated paying 6% on a mortgage is going to cost more than 1% will create in a savings account. These are the numbers many would face today. Actually, 1% interest is higher than many would get.

At 1% in 50 years $1 will grow to $1.645 (WOW!!!) savings???
At 6% in 50 years $1 will grow to $18.42 (OUCH!!!) mortgage costs

Going to 15 years at 1% $1 becomes $1.161
yet at 6% $1 becomes $2.397

Paying the mortgage off first saves much more than it costs.

In my scenario above I said the person got a 15 year mortgage and paid it off in 15 years. I did not even try to pay it off early. If you instead got a 30 year mortgage the added interest costs involved both in time and the higher rate would cost even more.
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February 26 2011

For a qualified opinion on your personal situation, see a CFP or a CPA.  My personal opinion - home ownership isn't just about money.  It's about a place that is part of you and your family.  It's something that is part of our legacy that we leave to future generations, along with the memories that were created there.
Let's face it though - if you never pay off the mortgage, you don't own the home.  You're just paying rent to the bank.

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April 06 2011
Dan, I think that your point is well stated and actually share similar advice with my younger clients. Furthermore, the peace of mind of just knowing that you own your home is also very valuable to many people.
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April 06 2011
Profile picture for sunnyview
Peace of mind should never be a substitute for solid financial planning. Young and first time buyers tend to buy emotionally and they would be better off making their decision based on the financial end first.
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April 06 2011
Sunnyview - I understand your point, but there should be a balance between peace of mind and financial planning.  The purpose of sound financial management isn't always just to pay lower taxes or to put the most $$$ in the bank.  Sometimes financial security is achieved through risk management that provides peace of mind.  For example, when we tell our tax preparer to take out a deduction that will raise our tax payment, but will also lower our potential for an IRS audit.  Financial success and security isn't always measured in dollars and cents.  And there are a huge number of better ways to generate tax savings than the mortgage interest deduction.
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April 06 2011
Profile picture for sunnyview
Strictly speaking financial success is measured in dollars and sense. Peace of mind may not be. Real estate agents are not financial planners or CPA's. Often when they help clients buy, they do not look at the house or consider the house as financial tool. If they did, discussions of PITI vs fair market rent would be part of the discussion along with historical appreciation for that specific neighborhood vs others.

Buying a house is a balance. I do believe in homeownership, but I also believe in a return on my investment. People may have to give up a higher percentage return on their money over a strictly rental property to have the type of house that that they want or the schools that they favor. However, they need to be aware of the trade that they are making and buy using some criteria other than emotion alone.

You can have both and do not have to forgo making a good choice to get the house that will also further your financial plan.
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April 06 2011
Profile picture for mckylie
I am all for paying it off IF you can also save for retirement and have money in reserves as well in case of emergencies.  Yeah, with a Mortgage you get to deduct the interest but as someone said before it's not dollar for dollar.  And you are paying so much more than just the principal for the house.  It's nice to know that if you had to sell your house for some unforseen reason you will actually get cash back and not have to short sell, foreclose or come to the table with money!  And if you do run into financial hardship and don't have "enough" money for living costs you can sell as well and have that cash. 
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April 06 2011
Profile picture for user8801190
STUPID ADVICE!  I paid off my house in 5 years (139K)...every dime my wife and I made!  the payment was $1360 plus.
after the house was paid we danced in the streets and have never struggled again.   Most of our friends did NOT pay off their houses and long story short no longer own houses!  forget tax write-offs.  get rid of the biggest bill in your whole life and that is a mortgage.

We also drive used cars and have liability insurance.  My biggest bill in life is my electric bill....about $170 a month!
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August 28 2012
i guess im old school. im 59. self employed since 1977. in my wild and wooly days i made lots of money in real estate. buying ,selling.investing.i used to buy one, sell, buy two , sell one, keep one. i struggled with barely making the mortgage payments on my rentals. there were many many times when i had to take my hard earned commission checks to pay for the mortgages, repairs and vacancy. prime example is a 4 unit building i bought in 78 for 75k. i refied like everyone recommends for 150k.
took the the equity bought more. made money....lost money..broke even on some investments over the years. but i always had the vision that i would some day pay off the 4 unit building. and i did. now that property is worth
in todays market about 350 k. easy. however i get 5000 month rental income. if i sold and take the 300k  net and put in the bank i would get what? 3% x 300k = 9000 year. let me see.....5000 x 12 month = 60k.
i grew up dirt poor. my parents are from mexico. i have lived in mexico in dirt poor conditions. unlike americans, most mexicans because lack of financing own their homes free and clear. they work here to buy a piece of land. they build room by room . now that they are unemployed, they go back to mexico and dont worry about mortgage or rent payments.
my point is, it depends where your roots came from and the mentality
about having free and clear.
you do not know unless you have free and clear rental property what it feels like to have the rents come in and all you have to do is pay taxes, insurance and repairs. yes i pay taxes on the income i get .but guess what .even after i pay my income taxes , im still getting more than i would in the bank at this time.
are there other investments? yes.but at this stage of my life. looking toward retirement i dont want to gamble like i did when i was 29. and i  look at all the people that lose money in stocks, mutual funds, etc. many have lost more than half of the value.
many are in foreclosure or have been foreclosed on.
many have no jobs, many went from dual income to one income or no income. with a high mortgage, living expenses. etc.
so there is a benefit to owning property free and clear.
this may not work for everyone. but it works for me.
and that is the bottom line....you do what works for you....i do what works for me. thats what makes the world go round.
i may also mention that i have also my own home that is free and clear.
no ..its not in beverly hills. its in a modest middle income neighborhood.
but i feel so good that i can take some of the 5000 and go on a cruise with my wife. i can get a new car and make the payments. i got money in the bank for emergencies. and if i kick the bucket, my children will have a free and clear property. they more than likely will sell it and spend it in less than a year but if im 6 feet under, what can i do about it?
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October 07 2012
If your cash flow isn't steady and high, you may want to pay off your house. Ultimately what it comes down to is if you can take the amount of money you owe and make it grow at a rate higher than your mortgage interest, then its better to keep the loan. If you can't put your money somewhere where it will grow faster than your mortgage interest rate, then pay off the house. 
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October 08 2012
 
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