Amy of My Debt Free Goal aims to pay off $72,900 in debt by April 2009. By her own admission and hoping to go farther than she would otherwise. Paying off that amount involves throwing over $3,000 per month, every month, at that debt for the next two years — and that's just principal repayment! This says nothing of the interest payments.
No matter. The one thing I've found out is that bloggers are very supportive of one another, especially in their efforts to reduce consumer debt, so I know that Amy will get lots of encouragement and advice. She's even getting it on other blogs already!
I wonder why there's not the same urgency for people to pay off their mortgages. My mortgage, for one, is more than Amy's debt. I know many others have much bigger mortgage debts than I do. So why don't people put a fire under their butts the same way in reducing their mortgage debt that they would reducing credit card debt? The “payment” on the mortgage — principal plus interest plus other stuff like PMI, taxes, and insurance — is actually a minimum payment, much in the same way each credit card bill has a minimum payment due. So why don't people pay more than the minimum on their mortgages? Some possible reasons:
- Mortgage debt is considered “good debt.” A mortgage is a much easier sell as far as proving one's financial acumen, since the debt is used to control something of solid value.
- Interest on mortgage debt is tax deductible. “This is the biggest tax break of your life,” I've been told. It is nice that Uncle Sam chooses now to give back some of the money I spend on mortgage interest.
- The interest rates are (usually) more manageable. Six percent is much more palatable than 19.99%.
- It leads to home ownership. Now, when the ownership happens is up for interpretation. I call the home mine when I've paid off the mortgage; most others call it theirs when the house is sold to them, regardless of whether there's a mortgage on the house or not.
- They can do better with their money elsewhere. For some this is true, but for a lot it isn't. Paying extra on your mortgage usually does about as well as an online savings account in terms of increased debt repayment (rather than getting interest, you get equity).
But unless you're well into your mortgage and almost have it paid off, there's no getting around that a huge amount of your payments go toward interest. You do get the tax break (under certain circumstances) but that's only a partial reimbursement. The rest is gone from your pocket.
If you haven't looked recently at how much of your payments go toward interest, you should reacquaint yourself with that number. Can you afford even an extra $25/month to pay down that debt faster? Once you have an emergency fund set up, if you don't have other high-interest debt, consider throwing a little more at the mortgage. It's still a debt monster that needs to be slain.
I think one reason why people don't pay extra towards mortgage is because a house loan is much larger than a regular debt. Is extra $25/mo really making a difference on a 500k mortgage? The answer is yes (saving you almost 1 year of payments, assuming a 30 year loan) in the long run but that's not that obvious at a first glance because of the huge difference between the two numbers.
Darius has got a good point.
I can probably afford to put an extra £25 per month towards my mortgage, and instead I'm putting it into savings. As it happens there are no tax benefits for me on mortgage interest also, the interest rate on my savings account is higher than the interest rate on my mortgage. So that makes more sense to me.
But maybe I'm actually doing it because £25 doesn't seem a lot compared to the £80K+ that I owe.
I think Plonkee is right. If you look at the interest rate of a 30 year mortgage and subtract the interest deduction vs. what you can make elsewhere, a 30 year mortgage is a VERY cheap debt. In my case the math works out like this: My mortgage is at %6.25. About 26% of that interest I get back as a tax deduction so the effective rate is 4.62%. My savings account earns 5.05% from HSBC. If you put the money in an index fund you can probably average even better returns than that- so it makes more sense to put the money elsewhere. Obviously there are other factors such as psychological or getting that 20% equity into a place that have to be taken into account on an idividual basis.
Justin – you are forgetting that you are taxed at the same rate on your HSBC earnings as what you save on your mortgage. Also, itemizing mortgage interest means losing the standard deduction, which I believe is a $10,500 for couples. ie, if you pay $12,000 in interest, only the difference between 12,000 and 10,500, or $1,500 is gained in deductions.
You're missing out on something big: Inflation
While in the last decade or so, inflation hasn't topped the 5-6 range, it has before.
If that happens again, you get a total *steal* on money that you've borrowed at less than that rate. Your mortgage rate stays the same (unless you were silly enough to by an adjustable rate mortgage), yet you can make at least inflation + 2% in interest, risk free on all the money you didn't drop into your mortgage.
As people will borrow money from me at the same rate I have borrowed from the bank (actually high interest savings accounts are *higher* than my mortgage rate), there is no reason I should pay the bank early until that changes
–Michael
Prepaying your mortgage will put a tremendous hurt on your ability to build wealth (assuming you would otherwise invest that money).
Average Pre-Tax Return on Stocks= 10.5%
Average Pre-Tax Return on Pre-Paying Mortgage= maybe 6.37%
When you factor in tax, the return gap is made even larger by the fact that the stock return is taxed at the capital gains rate.
There is no reason you shouldn't use the leverage of "good debt" to build your net worth, especially if you would like to retire early some day.
Remember: its not the amount of (or lack of) debt you have, that determines how well you are doing: it's your net worth: assets minus debt. Would you rather have $100K in assets with no debt, or $500K in assets with $400K in debt at a low interest rate? If your financial goals involve more than just treading water, than the latter choice is the clear winner.
Also remember to consider risk.
Investing in a mutual fund (even an index fund) carries MUCH more risk than paying down a mortgage (or putting the money in a FDIC insured account)
Paying down your mortgage is stupid. Find something better to do with your money…
Points you should consider:
1) You absolutely can do better with the extra principle invested somewhere else *cough*Vanguard 500*cough*. Nay-sayers claim that is risky, but they need to consider the time horizon here. 20+ years (the amount of time most people have left to pay down their mortgage) is plenty of time to weather any downturn in the market. Furthermore, the difference in the potential rates of return are enough to convince me it is worth the risk. Finally, compounding works over time. If you pay extra down on your mortgage now and wait to start "investing" until after you've paid off your house, you lose those years of compounding. Financial writers have shown over and over again that compounding a little over a long time wins out every time over waiting to invest till later.
2) Consider the "I" portion of your payment to be rent. If you didn't buy a place, you'd have to rent it. You are not throwing away the interest, you are paying rent for your house.
3) Michael's point above is great! Borrow money today and pay back with cheaper money tomorrow. This is brilliant! It's one area where inflation actually works for you.
4) By investing the money in the stock market you instantly diversify your investment and keep it in an almost liquid form. By paying extra principle on your house your have increased your risk because you are not diversified and you've also locked that money in a fairly illiquid form that is hard to turn into capital if an opportunity or emergency comes along.
5) And finally, paying down your mortgage is, fiscally-speaking, "stupid". Your mortgage is some of the cheapest financing you will every receive in your life. If you leverage that and make other, more lucrative investments you will come out ahead. Wealthy people don't pay cash for everything because they can do math! Dave Ramsey's 'debt is bad' zombies pay cash for everything because they can't do math. I wish Dave Ramsey would stop telling people "debt is bad" and just teach them to do the math themselves. But math is hard…it doesn't sell books.
Wealthy people finance things all the time! I'm talking billionaires here. They are not stupid and they are not "wasting money" on interest. They simply know how to have their money work for them and create greater returns then they are paying in interest on the money. That is the secret to wealth.
This is a case where you need to run the numbers. In my case, I have a 15 year mortgage at 4.875%. Vanguard's Prime Money Market Fund is paying 5.1+%. It makes more sense to me to "prepay" my mortgage into my money market account since it earns a higher rate of interest. One could be more aggressive and put it into the S&P 500 index (but where will you be if the market drops 20%?). That is why it is called risk. By 2013, I will be able to pay off my house, less than 15 years after buying it.
The danger for my approach is that I see a huge pile of cash that I can spend, say on a trip to Maui, instead of paying off the mortgage. Discipline. Discipline. Discipline.
I am in favor of prepaying the mortgage for flexibility reason and I have taken a huge steps towaard it:
I am 30 years old with a wife and two young kids. We purchased a home in 2004 for 330k. My mortgage balance is down to 120k ( mortgage rate is 5%, 15 years ) and I want ti pay it down as quikly as I can.
My reasonning behind it:
==> Warren Buffet claims taht we should expect long term return is the 6% range for the large cap stocks. All asset class prices seems to be fairly expensive right now.
==> Both my wife and I are fully funding our 401k so we have good exposure to stock ( an d a little bit of bonds). I am prepaying my mortgage not with money assigned to retirement but from our frugal living. It helps getting diverisfied: I am not suire I want 80% of my wealth tied to stock versis 20 in my house and the otehr way around is true also: I do not want too much in the house.
==> Flexibility. Once the mortgage is paid down, flexibility will be much greater in terms of investment opportunity. I believe that volatilioty in the finance market and job flexibilty will shape tomorrow's world so I want to be flexible.
==> Yes inflation plays against me but even though cost of goods increase, I believe the wages increase do not follow so what was good in the seventies for our parents were both Proce of goods was increasing and wages also ( resulting in much lower % of your salary going to your mortagge even if your payment was fixed) is too probable now
ANy feedback appreciated
"I call the home mine when I’ve paid off the mortgage; most others call it theirs when the house is sold to them, regardless of whether there’s a mortgage on the house or not."
I call the home mine when I have title and possession, regardless of whether there's a secured loan on it. That's the law in my state. I do know that in some states, mortgagees are allowed to hold title to the property until the debt is paid off. In that case, I could see saying that the bank (or mortgagee) owns it. However, most state's laws are like mine. I've lived in my house 9 years and have about 65% of the mortgage paid off. It's mine. True, the bank could come and foreclose and take the property given certain situations. But so could the state if I don't pay my property taxes. Does that mean that even if after I pay off the mortgage, the state owns my house because it has the option of foreclosing to collect delinquent property taxes? I don't think so.
I can see both sides of this issue, especially since my husband and I just bought our first house. In our case, we got a "piggyback" 15% loan in addition to our 80% loan, as it was cheaper than PMI. The smaller loan has a balloon payment after 15 years, so we plan to pay extra right from the beginning – lots of small additional payments ($100 or so) is easier than one large payment (>$5000) 15 years from now. Our "regular" mortgage we'll probably leave alone, paying just a little bit more than the required payments.
We don't have any "bad" debt, but we do have hefty student loans, so we often play the game of "which debt do we make extra payments on?" We know that our income will go way down once we have children, so we're trying to get all this "good" debt to a level that we can manage on one salary.
I can easily see both sides of this argument as being valid, but only if one factor is completely ignored; length of ownership. This issue is one that I haven't seen mentioned in the article or the comments so far and to my mind makes a huge difference in a persons outlook at the entire mortgage as debt debate. For example, everyone is assuming that they will stay in the home for the term of the loan or longer, in which case this debate can go on forever. However, what if your time horizon is less than the mortgage term? How does prepaying benefit the homeowner who plans to live in that particular home for only X number of years before buying something else? How about the upwardly mobile careerist who knows that they might be relocated to another city at some indeterminable future date? All of these factors change the prepayment scenario to such an extent that, to me, prepayment becomes a bad financial decision. And since the average American lives in their home for 7 years or less, I believe that for most Americans (not all, MOST) making extra principle payments on their mortgage is a bad idea.
Excellent points. Have any of you considered owning multiple houses? Let's do a scenario, my scenario. I have $2000/ month in debt. My mortgage consists of $850 with $250 in misc. tax. This alone is a huge burden and a liability. What is investment, really? A belief that you will earn your money back and more from giving it to someone else. Why would you risk your family's livelihood on accruing and keeping any debt, whilst giving your money to someone else? A simple sentence has set me straight, "Money is opportunity." Therefore, try to follow some simple guidelines of mine. MATCH YOUR 401(K) MATCH. Pick a fixed amount of monthly surplus cash, and any windfalls (raises, two "extra" paychecks / year, etc.) and dedicate it to paying back the people who "invested" in you, and as you pay off your debts add those payments to your other debts. I also take a $1/ day and invest in in bonds/t-bills, JUST IN CASE. If you have ANY left over money invest in an on-line bank acct. for at least a 5% return, and once you have enough to invest in stocks through a discount broker, like e*trade with $1000, then go ahead and sock it away in some company that will almost definitely earn a decent rate of return over your lifetime, like Microsoft, Coca-Cola, Alcoa (DOW). When your debts are paid off, you will be free and clear to really start investing in the country's economic fortune by taking a considerable sum of cash that you were dedicating to debts and earning "no risk" returns, because you don't have to worry about your month to month paycheck keeping a roof over your head anymore. Peace of mind and paying off a 30 year mortgage in 6 years, along with 2 car payments, 2 student loans, 6 credit cards is well worth the accomplishment. When you go back to your ten year reunion, wouldn't you like to say that I already own my house, have no debt and would be interested in donating $10,000 to your old sports team, school, community, scholarship or whatever and have that be your tax deduction. There is one other caveat to this scenario. DEMAND to make more money and always be prepared to make more by working smart, hard and walking through the door of opportunity when it opens. Good luck, but you probably won't need it.
Now, when the ownership happens is up for interpretation. I call the home mine when I’ve paid off the mortgage; most others call it theirs when the house is sold to them, regardless of whether there’s a mortgage on the house or not.
I agree with Rachael that a house is actually yours when you have paid it off completely. If you still owe anything on the house’s mortgage, how can you claim to truly own the house? But you can still claim to own a certain percentage of the house. The more you have paid on the mortgage, you end up “owning” more of that house.