The day I closed on my mortgage refi, back in the summer of 2013, I remember excitedly telling my boss at the time that inflation was going to eat my interest rate.
I was closing on a 15 year mortgage at 2.75% interest. An interest rate that was historically low, I had never seen before, and I suspected we would never see again. And I was right – I rarely find someone with a lower rate than I have.
Currently, I’m working on paying off my mortgage. Sounds like a great goal, right? But more and more often lately I find myself questioning it.
After all, becoming totally, 100% debt free sounds amazing. And I have reasons to want to free up the cash flow that I currently direct towards mortgage repayment.
But I also know that it’s mathematically stupid. And it’s becoming more so every day, as interest rates finally come up from zero. So today I want to take a critical, objective view of my plan to see if it holds up today in 2019.
And then do the real equation, which is Math + Life = Decision.
All About My Mortgage
As mentioned above, we refinanced for the last time in the summer of 2013 into a 15 year mortgage at 2.75%. The old mortgage had been a 30 year at 5.375%, which meant the payment actually didn’t change at all.
It wasn’t our first time refinancing. When we purchased the home in 2006, our interest rate was around 6.5%. We had refinanced once before 2013 to shave over a
After my husbands
So we refinanced into that low, low rate mortgage to be paid within fifteen years. I would be around forty-eight, and my husband fifty-four, if we didn’t pay an extra dime.
That mortgage is now five and a half years old, and the principal has melted off. We now own over half the house, based on the original purchase price of this house. In five more years, we will own over two thirds. And in ten more years, it will be gone.
But I have a different goal. I wanted to enter my forties totally debt free. And so we embarked on the unusual debt payoff strategy of accumulating money in a mortgage payoff fund while paying on the mortgage.
Why Is This Stupid?
Let’s start with a critical look at the current interest rate environment.
Remember, my mortgage is currently at 2.75%. It is not deductible on my taxes as I talked about last week, so my after-tax rate is 2.75%.
I’m currently earning 2% in a federally insured money-market account. It looks like there are accounts paying upwards of 2.25% (as of this writing).
You can earn over 3% in a five year CD.
Heck, iBonds are paying 2.83% right now.
So I was right back then when I said inflation would “eat this interest rate”. It is eating the rate. In one more year, will I be able to get over 3% in a savings account? Will the accounts eventually get back to where they were when I was in my 20’s, at over 5%?
Who knows? But it’s starting to look like we may be financially better off keeping the mortgage, and keeping the payoff fund in an account that earns interest.
But Would We Really Be Better Off?
Unfortunately for me, you can’t just compare (say) a CD paying 3.1% and a mortgage at 2.75%, and declare that the CD will be the better financial choice.
Remember that the savings accounts, money market funds, CD’s and iBonds are all taxable. Meaning that I pay my marginal tax rate on any earnings. This brings my effective rate down. I also pay my lovely state taxes, in addition to federal taxes.
Thank you, tax man, for making my financial life more difficult.
Luckily calculators exist to help with this very problem. I found this one from Calc XML that helps you figure out your after-tax yield. At my tax rates a 3.1% taxable yield is effectively 2.23%.
Less than my mortgage.
In fact, I would have to earn about 4% in a taxable account to hit an effective yield of over 2.75%. That means until risk-free rates hit 4%, I am still mathematically better off paying my mortgage.
Math is only part of the equation – life is the other part. There are several non-mathematical considerations in our lives we just can’t forget.
Four Non-Mathematical Considerations
There are several important pieces to this puzzle we call life, above and beyond the simple math question.
Pieces like:
In two and a half years, my oldest son goes to college. College means paying for college. A mortgage payment is going to restrict our available cash flow to fund college payments. We do have money set aside to help pay for his college, but there are also two more kids right behind him. Being mortgage free means more cash available for his and his brother’s college funds.
Debt freedom is important to us. We’ve worked hard, for years, to reach this point. We’ve saved when we could have spent. Eaten at home, hung laundry to dry, had tons of free and frugal fun, and basically lived well below our means to fund our dreams. One of those dreams is total debt freedom.
Owning our home removes a risk. Ever since I sat beside my husband and watched that ventilator breathe for him, knowing there were two young kids at home, the weight of debt has hung heavy on my chest. If we own our home, then no matter what happens (assuming we pay the taxes), it can’t be taken away. We will own it. Losing it to foreclosure is a risk that goes away forever.
The point of all this isn’t to have the most money possible. Sometimes, in the pursuit of efficiency and earning more, more, more…we lose sight of the fact that the point is not to die with the most money mathematically possible. No one will be putting on my tombstone “she paid off a 2.75% mortgage early” with a “LOL” emoji carved next to it.
Then what is the point? The point is to reach the goals that are important to us, and to live a life in alignment with our values and dreams. If those dreams include things like paying off a mortgage, even if it’s not the best financial decision, then that’s great.
Make your dreams come true.
You Do You
Were you in my situation, perhaps you would keep the mortgage forever. You would arbitrage the interest rate, invest everything into penny stocks/real estate/index funds, and keep the mortgage as long as possible.
In fact, you might not have gotten a fifteen year mortgage in the first place. At the time I refinanced, 30 year mortgages were going for 3.5%. You would have gotten that low, low rate and kept the mortgage the full 30 years.
You’re not me, though. I’m pretty sure you didn’t have a husband who lost his job in the Great Recession. Your husband didn’t almost die when you were in your early 30’s. You may not have been supporting your family on a single income for the past four years, because your spouse was at first unable to work, and later decided as a family it just made more sense to have a stay at home parent.
You also perhaps didn’t have a child at 23, and need to worry about sending him to college when you’re forty. Maybe you didn’t start off with a low income, and gradually bring it up over time to the point where you need to expect to bear the full financial burden.
Point being, you’re not me. You don’t have my hopes, dreams, background, or life situation. You’re you. I’m sure you have valid reasons for the decisions you make, in the context of your life.
And I have valid reasons for mine.
I’m still going to pay off that mortgage.
Even if it means I’m mathematically stupid.
What About You?
Have you ever made a decision that mathematically was wrong, but you did it anyway because it aligned with your goals and dreams? Or are you more of a “pure math” decision maker”? Let me know in the comments.
Ha! After reading this post, I’m more convinced than ever you *shouldnt* pay it off, and I believe in paying off your mortgage (you know we love our fifteen year mortgage too!). Why? Because once you’ve put all those savings in your mortgage, you can’t get them out again if you have another dehabilitating family crisis. If you get sick or injured, what are you guys going to do? I think it makes more sense to keep all those savings you’ve worked so hard for, knowing they’re there to pay off your mortgage, but having them fairly liquid in case of a big emergency. Because once they’re used to pay off the house, you can’t get that money back out very easily.
I agree with this comment. Save the money to pay off the mortgage and keep it in a safe high interest account. You peace of mind will come with knowing you can pay off the mortgage whenever you want, but choose not to. You will have a safety net of cash in any emergency that might pop up in the next ten years. If you only have a single income and you lose a job, you would regret piling all your free cash into a house. It also would be a pile of money you could chose to invest should another big stock market correction occurs.
Liz,
Thanks for the provocative and candid post. The reason I love reading you is your willingness to be publicly accountable and vulnerable in your decision making process.
Like international stock allocation, paying off a mortgage is a deeply personal bordering on religious belief that reflects the baggage we bring from living life.
It makes perfect sense in the context of your experiences to get rid of it and move on, enjoying debt free living.
To a stress free next decade,
CD
This is why personal finance is so personal! I’ve been in my current place for 7 years this year and in the first 2.5 years, I paid off half the mortgage which was an ARM at 2.5%. When the ARM reset, we refinanced to a new ARM at 3.09% with a 10 year amortization. And now it’s small enough that I don’t think I would pay it off until one of us gets a bonus larger than the balance since, though that would probably happen around the next reset point.
That’s all moot though because we plan to sell this place this year and we are buying a new place. Originally we planned to roll all of the equity from this place into the new place, but we likely won’t do that after all, which is weird to me after paying down this mortgage so aggressively. We want to get to our coast to FI at goal age number before focusing on the mortgage.
I think my struggle with your mortgage payoff approach would be the fact that I wouldn’t be able to bring myself to sell investments to pay off the mortgage! Once I reached the equilibrium point, then I would pay off the mortgage with cash flow going forward.
This is one of my favorite topics to discuss. I converted to team “pay off the mortgage” about three years ago after waivering between investing the excess and paying more on the mortgage.
The math may never make sense but the behavioral impacts are significant.
I’m glad that you and your family have decided to go all in the pay off the mortgage. I don’t think you’ll ever regret it once you get there.
Liz:
I bought our house in 2011 on a 30-year mortgage. Dr. SoS and I married in 2013. At the time, I thought that taking advantage of the low interest rates and refinancing to a 15-year mortgage was a good idea. We refinanced at 3.125%, which is the same rate as her student loan.
Since that time, I considered multiple times if we would have been better off refinancing to the offered 30-year mortgage at 3.25% and using the extra money to pay on her student loan.
I recently came to the conclusion that we made the right decision. Since I took out the original loan in 2011, our payment each month nearly doubled when we refinanced. The 15-year mortgage forces us to pay our debts more quickly than if we were more in control of the money. We now have less than 10 years left to pay off the house. We would not have been as diligent using that money for her student loan as we have been to keep our large mortgage payments current.
You are absolutely correct. Each one of us has a unique situation and many things need to be considered when making financial decisions, especially the large ones. We would rather not pay a mortgage in retirement. This is enough motivation for us to continue on this path toward freedom from our debts.
Kindest Regards,
Mr. SoS
I understand this. After going through a divorce and living off of my one income for the past seven years, I look at my financial decisions a lot differently. Each of our own life situations dictates our comfort level with different things. I love following your blog!
Great article. I don’t think paying off debt early is ever a bad choice. Mathematically optimal? Maybe not. But as you highlight, there is more to it than math.
Overall, I like the idea of saving extra principal payments in a brokerage account instead of actually sending it your mortgage lender. When the balance equals your mortgage, you pay it off. Along the way, you have some liquidity in case life throws you a major curve ball, or you decide to start a biz, buy a rental property, or renovate part of the house. This approach requires some discipline though.
You’re absolutely doing the right thing.
I made the same decision as you, (leaving your marriage with 4 kids under 5 and $60 cash to your name really makes you value security.)
Your husband’s illness was clearly akin to my experience. There’s a lightness in how you hold yourself when that mortgage is gone. And yes – then you start feeling rich because suddenly, you have So Much Money available every payday!
Love’n it! We’re in the same boat. Closing in on paying her off before this spring. We refi’ed into a 5-year ARM at 2.65% about four years ago. Idea was to have the house paid off before the five years were up (2020).
I agree it’s a tough call when you could conceivably yield more return in the market. BUT, I like the idea of having more cash flow absent a mortgage payment. AND I consider a mortgage paydown a safe, bond-like hedge against a volatile market. You could do much worse than paying off your house.
well we’ve been there and done that. it was around 4 years ago we paid off our close to 6% mortgage. it was under 50k when we were tempted to re-fi at those low rates but it made less sense with closing costs factored in. i was round 46 and mrs. me was 50 and we were both working. we had plenty of liquidity in a cash e-fund and wanted to be debt-free with all that great extra cash flow. a funny thing happened after that: we found ourselves down to one income but it didn’t wreck our fun lives. we pretty much have lived the exact same way and being 100% debt free is life changing. there are no guarantees of return in the markets.
Amazing and thoughtful post, Liz! We, too refinanced for a 15 with lower interest and can’t wait to pay it off.
I’m in the same boat, with my first kid going to college this fall.
I’m also of the mindset that even though I could be earning more in saving with that money, I choose to throw as much money into paying off the mortgage as I can.
Because there is nothing quite like the feeling of absolute debt freedom.
I live that you take the math approach and life approach, where each case and each person is so different that the outcome of their decision may have very unique factors, like yours with your hubby almost dying and your decision to have a stay at home parent, etc.
Love your insight!
Such a thoughtful and detailed post. You’ve made a clear demonstration of why you should keep paying it down. The tax pieces is something people often forget. I also appreciate that you used a “safe” return rate as a comparision, when the math arguments generally assume the 7% rate of return or more. There is a level of safety in paying debt that there isn’t in an investing environment, and we each have our own appetite for risk.
The pyschology of personal debt aversion and safety of home ownership are also hard to quanitfy. I think you’ve quantified yours well!
We are paying ours down faster as well, even though it’s a mathematical loss if we were to assume 7% or better. Definitely not a loss if we’re using safe returns. (I wish I had your interest rate!) We’ve chosen to balance the math/risk aspect by timing it so that we’ll be mortgage free at our projected FI date – everything else we invest.
Loved this post. Thanks.
As the wife of someone with a chronic illness, I just want our debt GONE. I appreciate articles like this one that takes things other than math into consideration. Thank for writing. 🙂
The decision depends on the difference between the emotional and the pure math approach. The bigger the amount the more I am shifting towards the pure math way. There is an amount I could sacrifice on the altar of emotional decision making but it should not be significant.