Should You Pay Off Your Mortgage Early?
The honest but often frustrating answer to the above question is, as with almost all personal finance questions, it depends.
However, in an attempt to give a less frustrating answer, let’s take a look at a simple example of paying off a mortgage early versus investing.
Ok, here are the details:
Mortgage Balance: $500,000
Term: 30 years
Interest Rate: 5%
Monthly Payment: $2,684
With those loan terms, the total amount of payments over the life of the loan would be $966,276, including a total interest cost of $466,301. That big interest outlay over the course of a 30-year loan is what terrifies people and is one of the main reasons cited for wanting to pay off a loan early.
But while compound interest can work against you, it can also work for you.
Let’s look at two scenarios.
Scenario #1
Pay $1,000 extra toward the mortgage each month until it’s paid off. After the mortgage is paid off, invest the same $1,000 until the end of the 30-year timeframe.
Monthly Payment: $3,684
Total Interest Cost: $238,540
Mortgage Payoff Time: 16 years; 9 months
You would save $227,761 in interest and pay off the mortgage 13 years early!
After the mortgage payoff, you would then invest:
$1,000 per month
For 13 years; 3 months
At an 8% annual return (the average long-term return for the U.S. stock market has historically been 10% per year, but best to be conservative in our estimates)
Your portfolio value at year 30 would be $281,435.
After 30 years, the end result of Scenario #1 is:
100% home equity
$281,435 portfolio value
Scenario #2
You don’t pay an additional dime towards the mortgage, instead, you invest the extra $1,000 per month.
Minimum monthly mortgage payment: $2,684
Invest $1,000 per month
For 30 years
At an 8% annual return
Your portfolio value at year 30 would be $1,490,359.
After 30 years, the end result of Scenario #2 is:
100% home equity
$1,490,359 portfolio value
In both scenarios, you own 100% of the value of your home after 30 years.
However, by choosing to pay off your mortgage early over investing, you would have $1,208,924 less in net worth.
That’s a pretty significant difference.
Now, some of you may be saying, “Well, after I pay off my mortgage I’m going to take the payment and invest all of it now that I don’t have that monthly expense.”
In my experience, that idea sounds good in theory but I rarely see it actually happen. Some other expense will rise to take its place; whether it’s moving to a newer, now-more-expensive house, or it’s finally time to update the home with a serious remodel, or even just one or two more vacations each year now that you don’t have to worry about a mortgage payment.
Regardless, for the sake of the exercise, let’s assume you invested the entire monthly payment after you finished paying off the mortgage.
3,684 per month
For 13 years; 3 months
At an 8% annual return
Your portfolio value at year 30 would be $1,036,807.
You would still come out with $453,552 less in net worth. Which, for most people, equates to several years’ worth of spending in retirement.
Of course, this is just a spreadsheet answer and most people don’t live life in a spreadsheet. In the real world, there are multiple variables at play.
When you pay extra towards your mortgage your rate of return is essentially equal to the interest rate of the loan. It’s a guaranteed return on your money. While historically investing has produced a long-term return of above 10%, there’s no guarantee that will be the case over the next few decades and investing always comes with volatility.
Some people may not care that paying off their mortgage early isn’t the most optimal use of their money. They just want the peace of mind that comes from getting rid of their debt payments. The emotional return is huge.
Anyway, I hope this exercise helped provide a framework for how to navigate making your own decision. Whatever you choose to do, just be intentional with your financial decisions.
Thanks for reading!