Should You Pay-off the House?
| September 13, 2011 | Posted by Roshawn Watson under Uncategorized |
By: Roshawn Watson
You should maintain adequate liquidity, especially in today’s challenging economic times. Since the Spring of 2008, I have AGREED with Suze Orman: keeping at least an 8 month emergency fund (more on this in an upcoming post) seems reasonable to me AFTER you are debt-free excluding the house.
I submit to you that this IS risk-adverse and also a NECESSARY precaution. Consider the following as the rationale: 1) job-security is an illusion, 2) most real estate values have seen significantly better days, 3) it’s hard to convince yourself to sell equities in an emergency (especially if the market happens to be down), and 4) it may be hard to obtain loans from banks when you need it the most (instead they may close your line if they aren’t certain they will be paid back).
Paying $10,000 to Save $2500
Perhaps the most absurd reason to keep mortgage debt is to take advantage of the tax deduction. Now, I’m not denying that the tax deduction is beneficial, but I will submit to you that it may not be financially wise to pay the bank $10,000 per year (i.e., your mortgage) in order to avoid paying the IRS $2,500 per year (i.e., the extra amount you would pay in taxes if you didn’t have the mortgage). If you really want a tax deduction without wasting money, consider giving some money away to a charity and itemize. Of course, you would have the added benefit of doing some good in the process while increasing your bottom line. I suspect that is a lot better than merely making your lender richer for the privilege of keeping a mortgage around for longer than necessary.
Everyone is in Debt… oh Really
First, to assume that everyone has a mortgage is faulty. According to the US Census Bureau, about 30% of homes are owned free and clear, with the housing expenses of those with mortgages being approximately 3.5 times that of nonmortgage homeowners. Of course, many people rent as well. What I find more interesting is not the fact that people operate without debt but rather who operates without debt. Sometimes there is the presumption that if you don’t use debt, you are not financially sophisticated. However, this is an unsubstantiated claim. Consider that, since debt is typically your second greatest expense, eliminating debt often liberates one to build wealth. That’s because your income is your most powerful wealth-building tool. Accordingly, it should not surprise you that 75% of the Forbes 400, the 400 richest Americans, say that the best way to build wealth is to become and remain “debt-free.” In other words, keep the debt at your family’s own financial peril.
But They Approved Me
Some people confuse making enough to obtain a loan with financially winning. All the former means is that the lenders deem you a worthy enough risk to make them rich. Congratulations …I guess! However, who is making you rich? Just because you can obtain a property doesn’t necessarily mean that the cost of maintaining that property won’t BURY YOU. Do you know with certainty that your housing costs do not exceed what’s reasonable given your income level. Despite more stringent lending standards, some people are still getting taken for a ride. It’s simply a fact.
Parting Thoughts
The sooner you get rid of your housing debt the sooner your living expenses shrink and the real fun can begin. Again, your most powerful wealth-building tool is your income, so it would serve you well to not burden your income with loans, especially long-term loans. My fellow savers and investors know what it is like to be able to bank a mortgage a payment or two on a regular basis; if you do this consistently, you will be in a position to GIVE away a mortgage payment! (If you find that statement shocking, this is where the increased liquidity associated with reducing one’s housing expenses may come into play)
No house is worth your financial security, nor is that house a badge of honor. It’s the paid-for house that is the true badge of honor! Are you going to be (or are you already) a part of the 30% who will make this YOUR reality?
Related Post
Is a 15-year Mortgage For Everyone?
Copyright 2012, Roshawn Watson, Pharm.D., Ph.D. All Rights Reserved.
Very well said! I was surprised to learned that "75% of the Forbes 400, the 400 richest Americans, say that the best way to build wealth is to become and remain debt-free."
If 75% of the Richest Americans say that, it should hold some weight!
Good to see you posting again!
Hope to read some more!
My recent post Choosing Your Fixed Mortgage, 15 vs 30 Year
Thanks so much Money Reasons. It carries some weight indeed, at least to people like us. Hypotheses that have data supporting them rather than popular opinion wins everytime.
Glad to be back.
Kind Regards,
Shawn
So true Roshawn! Almost anyone can get a loan for a house, but your true worth shines when you manage to pay it off in full and own it fair and square!
Excellent, thought-provoking post!
Absolutely!!!! Thanks so much.
I agree 100%. An easy way to pay down the mortgage is to send in an extra principal payment each month. It is eye opening to see how much you have to pay off over a 30 year period if you just make the regular payment.
Thanks very much. That's completely true about how much cash we WASTE by keeping the mortgage. What an awesome point! It is amazing how quickly you can get rid of a mortgage by even paying 25% more.
Although my only debt is a small mortgage, I am on my way to pay it off . I will be retiring in less than 6 years and want it paid off.
Good to see you posting again.
What an awesome way to enter retirement: without debt. Your living expenses will hopefully be dwarfed, which means it is easier to build and preserve wealth (i.e., during retirement). I follow completely and agree. Kind Regards, and it is great to be back.
FYI, like you, our mortgage is our only debt, but we are selling the house; hopefully, it will be gone soon.
I have paid off my mortgage. but I'll play devil's advocate here…… and argue as Ric Edelman does that you want to have a big, long mortgage. The thinking here is that 1) your mortgage is the cheapest money you will ever borrow (especially these days); 2) liquidity is more important than paying down principal (especially if you lose your job you'll have extra money to keep the house until you find other employment); and 3) investing the money you would have used to pay will principal will net you a higher return than what you save on interest after 30 years, especially considering your mortgage payments are subsidized by the interest rate deduction.
My recent post The Calculus of Green Jobs
Biz, first let me say congrats on paying off your mortgage. I love this scenario. I will concede that the mortgage is cheap debt in this environment. However, I disagree to a certain extent that liquidity is MORE important than paying down your principal as an absolute. I believe people should have liquidity before paying off their homes. However, I define liquidity as having a fully-funded emergency fund at a minimum, which is 8 months worth of expenses. Some people, i.e., those with extenuating circumstances could justify more. I completely disagree with the last statement because the returns a) are not adjusted downward for taxes and b) are not adjusted downward for risk (a paid-off home is intrinsically and intuitively less financially risky than a mortgaged-home). Lastly, I don't speculate on my home, but that's just me. I love the discussion old friend.
Glad to see you posting again! I missed your thoughtful articles.
We are paying down our mortgage every month. It will still take forever to pay off though. At this point, it seems like the only way to get rid of the home mortgage is to sell the place…
On the other hand, we just closed on a 4-plex investment and I would love to hear your thought on that.
My recent post Our 4-plex Investment
Thanks so much. I'm glad to be back.
Your mortgage – If you're consistently paying extra, I suspect you're making significant progress.
Your 4-plex – I love real estate; I'm a pretty conservative investor; this does sound in line with your retirement plan.
Cheers!
The return on paying down your mortgage is 4 – 4.5%. The long-term return of a balanced portfolio investing the extra money is 7-8%. If you lose your job and can't make the mortgage payments, the bank doesn't care that you have paid extra principal. All they care about is that you can't make your next payment, and you're stuck in a bad situation you are equity rich and cash poor. The 3% compounding difference between the two options is significant over 30 years, and provides a margin of safety for bad times.
My recent post Quote of the Day: Henry Ford
Hey Biz,
You are making some assumptions that I wouldn't. First, the balance portfolio return of 7-8% per year is not excessive, but there are plenty of people who failed to achieve that this past decade. In fact, most people didn't achieve that according to the numbers I have seen. That return is NOT guaranteed; long-term things look good, but short-term, you certainly can't count on it. This brings me to point number 2: who said anything about keeping a mortgage for 30 years. I was thinking i.e., perhaps 5-7 years. If you plan to keep the mortgage around for 30 years, then that changes the whole argument entirely. That's way too risky for me. Third, even if the debatable 3% spread did exist, it is considerably less once you count taxes that you would pay on investments gains and risk (a paid-off home is considerably less risky than a home with a mortgage).
Lastly, with respect to the bank, if someone is so concerned, just keep a fat emergency fund, carry disability insurance, and consistently improve your skill sets. There are no guarantees, but we do hold considerable power over our destinies.
Cheers,
Welcome back, Roshawn. I'll take you off the list of deceased blogs. The mortgage is the only major debt we have, and in the next couple years, we plan to make a sizeable dent in it.
Thanks so much Andrew! Yes, please take me off of the decreased blogs list. Congrats on NOT having any debt, except for the mortgage. I'm sure you guys will eliminate it a well.
Cheers!
I think you are absolutely correct that a paid off mortgage is the ultimate goal, but I know so many people that can barely make their monthly payments and they can't sell because the market is so bad. I know other friends who are renting because they don't want to be tied down to a house due to the uncertainty of the economy. I would be interested to know your thoughts on whether the owners should pay extra on their principal and if the renters are right to keep renting and not buy a house? Thanks for the excellent article.
Hello,
I am a big proponent for being debt-free. I can understand NOT wanting to pay off a house early if a) you have other debts, b) you don't have adequate liquidity c) you are NOT investing for retirement, d) you haven't saved for the education of your children (if applicable). People can debate how much liquidity is needed; however, once you have adequate liquidity and have met the aforementioned criteria, it is certainly reasonable, and generally financially profitable, to pay off your primary residence. An important exception would be if you do not plan to remain there. In terms of renting, I have no problem with it, provided that you do so relatively inexpensively. All too often, we rent places that are too expensive while we are building no equity.
Thank you so much for the kind comment!!!
If investing in stocks at 7-12% were so much better than paid for real estate over a 30 year period, the bank wouldn't be loaning you money at 4% while bypassing this totally fool proof method of keeping debt to play the stock market.
If you had a paid for house, would you borrow 200k against it to go play the market? Hell no. (Credit that last quote to Dave Ramsey).
My recent post Do you own your home or does your home own you?
Andy,
That's such a great point! I love it. You're right that last example is classic Dave Ramsey.
Kind Regards,
Thanks for visiting