Should I Pay Off My Mortgage Or Not?

Refinance Your Mortgage And Enjoy Your Beautiful Home
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“Should I pay off my mortgage as soon as possible or not?” is a common question that many real estate investors wonder about. How do you decide?

The answer is pretty simple actually. You should pay off your mortgage sooner if you have the money. By the way, the sky is blue. Thanks for nothing, you're thinking. However, if you really think about it, that's the right answer!

It's all about balancing your debt/cash ratio. Build up too much home equity (prepaying) based off of your own principal payments, and you run the risk of blowing yourself up when there's a cash crunch due to unforeseen circumstances.

Related: Pay Down Debt Or Invest? and Invest In A 401k Or Save For A Downpayment?

Your conservativeness of paying down your mortgage ironically INCREASES your chance of financial doom.   Not paying down your debt sooner, on the other hand, inhibits you from maximizing your returns.  Dance with your mortgage without stepping on its toes!

Three Variables To Consider Before Paying Down Your Mortgage:

1) Interest Rate Differential

Should I pay off my mortgage? If your mortgage interest rate is more than 4% of your savings interest rate (i.e. 6% mortgage and 1.5% savings rate), try and throw as much money as you can comfortably afford at your mortgage. 

Remember, you pay taxes on your interest income, so the tax deduction on the mortgage interest is a wash. 4% is the critical spread, because 4% should also be your expected risk free interest return on your retirement portfolio.  By paying wider than a 4% spread, you're hurting yourself in the long run.

2) Money Choices

If you have nothing else better to do with your money, and feel secure about your job, pay down your mortgage as much as possible. Every dollar you use to prepay your mortgage returns you your mortgage interest rate.

In my case, prepayment earns me 5.25%, a 4% spread over current savings rates.  You may want to consider using your HELOC to even pay down your primary mortgage principal thereby arbitraging rates.

3) Duration of Stay

Still wondering, should I pay off my mortgage? If you plan to live in your house less than 5 years, do not pay down your mortgage. The more cash you sink into your house, the more illiquid you become.  

What if a hurricane blows away your house, then what?  Since the plan is to sell the house within 5 years anyway, what on earth are you doing risking your cash flow?  

Furthermore, you probably shouldn't be buying a house in the first place with under a 5 year holding time frame due to the 5-6% transaction exit fee.

Related: The Biggest Downside To Paying Off Your Mortgage

Conclusion

Should I pay off my mortgage? The best way to deal with your mortgage is to make extra principal payments with money you will not miss. If you don't have at least 10% of the value of your property in cash savings, forget about pre-paying as well.  

Consider pre-paying your mortgage as a luxury, which you can only afford when you are flush with cash. Every time you stop into your mortgage bank, pay down some principal.  

Even a couple bucks here and there add up over the long run and you won't even know it.  You never know when financial hardship will hit, so best to variably pay down debt as you go.

Shop Around For A Mortgage

Check the latest mortgage rates online through Credible. hey’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible.

This is exactly what I did to lock in a 2.375% 5/1 ARM for my latest refinance. For those looking to purchase property, the same thing is in order. If you’ve found a good deal, can afford the payments, and plan to own the property for 10+ years, I’d get neutral inflation and take advantage of the low rates.

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28 thoughts on “Should I Pay Off My Mortgage Or Not?”

  1. Down over here in the OZ (Australia), we have these things called offset accounts. Typically you have a savings account that you can deposit funds into to “offset” the interest of your mortgage. This enables you to make extra payments but have instant access to you money should you need it.

    Do you guys state side have anything similar?

    1. So you don’t have to pay interest on the principle if you have an emergency savings account, basically? I don’t think we’d ever have something like that in the US.
      When you take it out, do you have to pay the back interest, since it’s as if you never paid the principle in the first place? That’s all that would make sense to me…
      I could see investors in banks not liking this as well….

  2. Money Reasons

    With the interest rates so low, I’m still thinking about scaling up to a larger house. Mine is not bad, but I would still like some additional land!

    I don’t think with the rates as low as they are today, that I would pay extra on the principle. For my house, my initial mortgage rate was 6.75%, so while not real high… It was high enough to do extra payments.

    I don’t know if I trust the stock market anymore, or not as much as I use to… Perhaps real estate would be nice? Scary times in the investment world, and with our current government…

    1. Scary times indeed. Watch out for lifestyle inflation! It’s what happens once you’ve paid off all your debt like you have!

      Scary times indeed. I hope Obama raises income taxes in ALL tax groups by 10%! Equality and pain for all to fund record deficit spending! Wheee!

      1. That’s the first mention in this discussion of inflation, but I think it should be considered as part of the equation. If you have a fixed-rated mortgage and inflation grows at an average rate of 3% annually, over time you’re paying with cheaper dollars. If your wages grow in parallel, that mortgage payment gradually takes away less of your income.

        For the little it’s worth, I bought into a co-op apartment complex on Long Island in 1989, where the price for an 800 square foot 1-bedroom was $87K. Comparable units today sell for at least $150K, in line with inflation over the period. I took an adjustable mortgage because that’s the only kind the banks would consider for a co-op that was just being converted from rentals and didn’t have a high percentage of sales. The adjustable rate was tied to the 1-year treasury and couldn’t fluctuate more than 2% annually. I always paid a little more on the principal but for the last 10 years I’ve benefitted from low interest rates (currently 3%) and I now owe a whopping $23K. With nine years left to pay that amount, why rush to pay it off?

        1. If your debt costs only 3% and you only have 23K left, why bother indeed. You only bother if the spread is wide enough over savings like I’ve written, and if your debt is annoying you enough to pay it off.

          Inflation is a BEAUTIFUL thing for debtors!

      2. Money Reasons

        Yeah, I regret having to admit that since I’m debt-free now, lifestyle inflation has been knocking at my door. I’m resisting it as much as possible, but the summers out here are short and my kids are growing up so fast…

        Surprisingly, my family is what’s keeping us in our current house. It’s a good house and neighborhood overall, so it hard to leave friends and move to a bigger house.

        I agree with the taxes, but then again I believe 40% of the population doesn’t pay any income tax? I’m sure if the government did raise taxes across the board as you suggested, a year or less later, the present goverment would increase the child credit or introduce some other credit so that just the rich pay taxes again… I’m not rich or a high income earner, and even I see that it’s not fair (or maybe I’ve been reading Evan’s site too much!)…

        1. It’s the darndest thing ain’t it? Part of the reason why I went and bought a peace of property was b/c I actually wanted to have more of a purpose to work and save many years ago. The rental prop now has kept me honest in my spending habits, and I’m thankful for it.

  3. I agree that the mortgage should be paid off as soon as possible. My wife and I paid an extra principle payment each month and it was painless. The “…sense of freedom…” Rob mentions is awesome.
    The 4% rule is a good one.

    1. Roshawn @ Watson Inc

      Honestly, this is the reason why I pay extra. There is a level of freedom that it is even difficult to put into words that one experiences with debt freedom, not to mention less risk and increased cash flow.

  4. 5-6% fee…
    Realtors. Ugh.
    FSBO FTW.

    Also, if I owned the place in the picture for this post, I’d eat ice cream in every room of it.

    1. Hahaha, nice. You can have your ice cream, I’ll have my Strawberry seasonal cupcakes and we can sing a sing a long.

      The picture you see is The Breakers Mansion.

      5-6% realtor fees are ridiculous.

      1. I’m kind of attempting to buy, and avoiding my ‘half’ of the fees (though the seller pays all). You’d be surprised – some brokers don’t tell their sellers that they could just pay 3% when there’s no buying agent.

        Cupcakes are great, but I’m on team Pie.

      2. I originally went to college in Newport Rhode Island and lived in the mansion
        (converted into dorm rooms) next to the Breakers. My room was called the
        “round room” which was in the tower. I loved Newport RI very much, such a
        beautiful area. If you like the Breakers there are tonnes of other mansions in that
        area all along Bellview Ave.

  5. I refinanced my 30 year mortgage to a 15 about 7 years ago. Since my payment was dropping because of the reduced interest rate, it really wasn’t much extra money to get it down to a 15 year mortgage. I am thrilled I did that. 7 more years to go….

    I know that many advise that you should take that extra money and invest it in the market instead of your house. But, look at the stock market today- it’s a mess. You can’t rely on future stock market returns, but you can rely on not having a house payment if you pay off your mortgage.

  6. Do you have offset mortgages in the US?

    Here in the UK there’s a type of mortgage where you can save a tonne of cash (say £100,000) and offset it against your mortgage (which may be say £500,000).

    You can access your cash at any time, as if it was cash savings, but the effective ‘interest rate’ is much higher than the cash savings equivalent, due to tax advantages etc.

    1. Hmmm, never heard of offset mortgages. We just have Home Equity Lines of Credit, which are loans against the value of your house to do what you will. Right now, HELOC interest rates are at 3.25% or under, so it behooves people to use that money to pay down ironically the main principal mortgage which is likely 4.5%+ and arbitrage.

  7. The biggest benefit of paying off the mortgage is rarely noted. Once you pay off the mortgage, you forevermore have a place to live that you don’t have to pay for (except for property taxes and repairs). That gives you a sense of freedom that others do not possess. You will be more willing tham others to take chances in your career because you can get by on so much less if things fall through. Being able to take chances (act on opportunities) can pay off big down the line.

    Rob

  8. Using a real estate agent is like using an attorney, you will get what you pay for, and it’s hard in advance to figure out exactly what type of service you are paying for. If an attorney gets 33% of your settlement on a multi million dollar case…maybe 3% on a real estate transaction doesn’t sound so bad. You’re paying for their knowledge and experience. And you’re paying for their network – what agents they know who represent legitimate buyers for multi-million dollar properties. Otherwise you’ll have lookie-loos viewing and no offers. There really is a big difference from one real estate agent to another. let me put it this way – you’re paying this person to negotiate the highest selling price possible for you. If the first thing the real estate agent conceeds in negotiations is the full 3% commission – is this person a very good negotiator? A strong negotiator will more than earn their commission by negotiating a price that exceeds the 3% commission he/she makes.

    Remember that your home value is based on other properties that sold (and also took a 10% haircut) in the last 90-120 days. But most owners have the incomplete logic to think the property net value is $2 million, when it’s really $1.8 million (minus commissions and taxes). Plus you’re in California, excise tax might be higher than Washington….

    In a buyer’s market – which is where we are right now – and for the next 2 years until all the foreclosures and short sales soak up – everybody is asking for – and getting 3% of closing costs covered. For the buyers, the origination fee and discount point are based on 1% each of the loan amount. The remaining 1% covers all the services demanded by the lender-investor to satisfy their loan rules: escrow, title insurance, flood certificate, etc. It all adds up. On a very high priced property, you might get away with 2.25% and cover closing costs. This based on my experience in the greater Seattle area – California seems to be worse off than we are. I don’t think buyers have been paying closing costs in the Bay area for the past 2 years – or will for the next 2 years.

    You shouldn’t be thinking of selling at all in this market. It would be like selling stocks during the great sell off in late 2001 early 2002. Don’t sell when the market is at the bottom. wait for it to peak again in a new buyer’s market, then the buyer can pay closing costs, and you’ll have multiple offers to bid up the price. :)

    I am not an expert at investing, so I enjoy reading the other articles on your webpage. I would like to see all the folks who contribute to your site write in with ‘basic financial goals’ for all Americans. Things we should all learn by the time we start our adult lives regarding credit cards, mortgages, student loans, emergency funds, paying cash for goods, etc.

  9. Point of disagreement – for the transaction exit fee – sellers should not assume 5-6% of the selling price. They should assume 10%. Why? Assume 3% for the listing agent, 3% for the buyer’s agent, 3% to pay buyer’s closing costs, and at least 1% to pay county / state excise tax on property transactions. Yes, sellers always pay both the listing and buyer’s agent commissions. Quit whining, you don’t have to pay either when you buy your next home. :)

    It makes a bigger difference to pay it down during the first few years. If you want to see how much interest you will save, and how much time you shave off the loan, click on the BankRate calculator:

    https://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx

    I advocate at minimum saving 6 months of total expenses, assume if you lose your job you will get 6 months of unemployment and require an additional 6 months on your own before you find a job in this market.

    It doesn’t take a ton of money to accellerate your mortgage, just an extra $100-200 / month will do the trick.

    Finally – think about retirement. If you plan this home to be your long term home, will you be able to make the full payment after you retire? I’ve helped a lot of 40 year olds buy homes lately, most want to retire in 20 years, so better to pay a little extra, and pay off the home about the same time they retire. I’m not a big fan of refinancing every 6-12 months, especially with fixed rates so low (and bound to climb in the spring when the Fed eases out of the market).

    1. Hi Jana – Thanks for your thoughts! 10% exit fee for the seller? Damn! I don’t think I’ll ever sell any of my properties then. Would you say that rule holds true for high priced properties ie a $2million house? I think it’s ridiculous that a % is still applied. I ain’t about to pay $200,000 in fees to sell a $2million house for example. The leg work is the same as a $500,000 house!

      I’m all for a FLAT commission fee, just like the flat tax :) And no, I’m not paying the buyer’s closing costs. Buyers generally always pay their own closing costs at least here in the Bay Area!

      I agree about having the mortgage paid off timed with when you want to retire. That’s proper planning for sure. FS

  10. I respect your position, but about 8 years ago I read a book by the Motley Fool and they said NO don’t pay it off as fast as possible. Their reasoning? You can invest that money and actually make a profit. If you can get a 10% return on your cash, and have a 5% 30 year mortgage (I know nothing about mortgage terms, so I am just using this as an example), you should take the 10% because you are “making” 5% each year.

    What are your thoughts about that?

    1. David – My thoughts are that way too many people think they’re smarter than the market than their own good. 10% return on cash year in and year out? Only a small minority of people can achieve that type of regular return. Look at Madoff. He lured in BILLIONS of dollars by guaranteeing 10-12%. Clearly, it was a ponzi scheme and big time farce.

      When you pay down extra your mortgage as you go, you are practicing a proper discipline without risking your liquidity. Based on current amortization of my rental property mortgage, I’ve got about 18 years left on the 30 year term. However, I’ll probably throw $3,000-$30,000 at it a year, and I won’t even miss the money b/c it’ll be dependent on my year end bonus. I guarantee the mortgage will be paid off within 8 years so long as I have a job. The minimal positive cash flow becomes a full $3,500/month in positive cash flow/passive income once the payment is done.

      People get caught up with paying down the mortgage and not seeing their payment go down. That’s b/c the mix of principal and interest changes and only when the entire mortgage is completely done will you reap the rewards. I’m all for paying down the rental property mortgage ASAP. The primary mortgage, less so, but still it’s good to do so with any money you don’t miss.

  11. William & Mary

    I like your idea of “4% as the critical spread”, as it matches up with a reasonable rate of return on your retirement income. Good barometer guys.

    Every time I go into the bank, I pay off anywhere between $50-300 a month on my mortgage principal. Since I go to the bank 12-30X a year, it ads up! I’ve paid off about $2,000 already.

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