Why We’re Paying Off Our Mortgage Early

To pay off the mortgage early, or not to pay off — that seems to be the question on many personal finance blogs. The arguments against paying off the mortgage early go like this: you’ll lose the tax deduction, and you’ll be better off by continuing to make minimum payments (or even by continually refinancing) and investing the additional money elsewhere.

First, I’ll tell you the reason we’re paying off our mortgage early. It’s mostly emotional. I want to have a place to live that’s paid for. I don’t want to owe any money to anyone, anywhere, ever again. I want to be able to pick up and travel the world on a whim, because my bills are so low. I don’t want to be worried about owing money.

But for those of you who are less emotional, let’s take a look at some facts.

Yes, if you get a tax deduction because of your mortgage, you’ll lose that if you prepay it. But what’s the real value of a tax deduction? Of course, every situation is different, but let’s look at an example using real numbers from the U.S. 2009 tax table.

Suppose you’re married filing jointly. If your taxable income prior to any mortgage interest deduction was $98,950, you’d have owed $17,119 in taxes. If the amount of mortgage interest you paid increased your tax deduction by $10,000 more than the standard deduction of $11,400, and left you with a taxable income of $88,950, your tax would be $14,619. That means that you’d have paid $2,500 less in taxes, but you’d have spent $10,000 just in mortgage interest in order to do so. (Plus you’d have spent an amount to pay down principal; unless you have an interest-only mortgage.) I think I’d rather pay $10,000 less in interest than $2,500 less in taxes.

But in our case, that point is moot. I think we’ve only ever been able to itemize once on our federal return, so none of the interest we pay on our mortgage is actually tax deductible at all. So that argument is irrelevant in our situation, but it may not be in yours.

But what about the investing side of things? Well, suppose we invested the $1000 or so extra per month we’re paying toward our mortgage instead of sending it toward principal, and we did that for 20 years while we keep refinancing our house or moving up in house so that we never pay it off. At an 8% rate of return, according to this investment calculator at the end of 20 years we’d have $568,999 before taxes and inflation. More than half a million dollars sounds pretty darn good to me.

But suppose we go ahead and pay off our mortgage in 5 years, and then send $2000 per month toward investments. In that case, we’d only have $675,213 before taxes and inflation. (Clearly showing the value of investing early and often.) It does sound like it would be a better deal to invest $1000 monthly starting now instead of paying off our mortgage early.

Except that there’s something missing from that equation, because we’d also have a paid-for house that’s likely to be worth $225,000 or more in 20 years. So by prepaying our mortgage within the next 5 years and investing regularly we’d have investments (if we include our house) of $900,213 after 20 years.

So there you have it, some emotion plus 900,213 other reasons why we’re paying off our mortgage early.

The other big reason though is risk. While there are other choices (such as paying off a mortgage on schedule and never moving or refinancing) that could cause things to come out differently, the truth is that I just don’t know how things will go. I don’t know if I’ll be able to get an average annual return of 8%, on anything. I don’t know what life will bring, period. But I do know that if I pay off my house and have good insurance, that barring an act of God or war, I’ll have somewhere to live.

You might be choosing to do things differently, but be sure you’re making an informed choice that takes your own individual circumstances into account.

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21 comments

  • Curt

    Way to go – similar to my logic – we’re on track to knock out ours in 3 years. I work with a lot of very wealthy individuals, and one thing I’ve noticed from most of them is that most do not have mortgages.

    • That’s great that you’re on track to have yours paid off in 3 years. And good to know about the wealthy individuals — I don’t work with a lot of them, but most of the people I do know who are wealthy also have their houses paid off.

  • More power to you. I just refi’d and considered moving from a 30 yr. to 15 yr. loan, but just couldn’t swing it. How nice is it going to be when you’re all paid off!

    BTW- Thanks for the RT.

    • Oh believe me I’m looking forward to that day! I think we’ll have a party ;)

      And you may not be able to swing it now, but if you want to pay off yours early every little bit helps. (And you may be able to do more in the future.)

  • I love it when real numbers are used. I never ran the numbers for us to see if we’re making the right choice vs investing the extra $160 a month, but we’ve been overpaying our mortgage since we first bought our place in 2007. It should be paid off no later than 2017. For us, it boils down to security as well. We don’t pay enough in taxes to itemize and I want to be living “rent” free in 6 1/2 more years…we still invest other money in the stock market and we save in a 401(k), pension plan, and a Roth IRA…I think we have our bases covered. :-)

  • The math is great, but I think it’s the emotion that really tells the story here. Your gut instinct is right in these cases more often than not. There’s no doubt that you’ve made the decision that is most conducive to your happiness. It’s when people try to do what seems “logical” instead of what feels right that they can get into trouble.

    • Exactly. And even if the math came out differently, we would probably still pay off the mortgage early, because I’ve learned over the years that for me what I feel is what’s most important to listen to.

  • We do itemize. Currently our rate is 5.5% (yay Wells Fargo no cost refinance). So our effective interest rate is lower with the itemization.

    We are pre-paying our mortgage. If we buckled under, we could pre-pay it in 4 years. But we have decided not to go that route.

    Why?

    Mainly for diversification. We want a fully-funded retirement. We want 529 plans. We want to make sure that we’re putting money in the stock market on a regular basis in order to get average returns. We like the tax advantages of retirement and 529 plans. We don’t want to put all of our money in one place– a single house in a single real estate market. Of course, we’re not fully funding our tax advantaged retirement savings (yet) either… Mainly because we don’t have an extra 76K to fill out those accounts, but partly because we’re using some of that to pre-pay the mortgage. (It is SO weird going from only being able to put retirement money in Roth accounts to having way too many options.)

    So we’re doing some of each. Somewhere between 15 and 20% to retirement, 6K/year to 529s, and prepaying the mortgage. Recently we’ve added another $500/month to what we were pre-paying before, so now we’re on a 12 year repayment plan instead of the 29 that would have been remaining in our 30 year refinance if we’d just paid the minimum.

    We also have an irrational reason for pre-paying the mortgage even before I’d thought about the issues. Our mortgage is something like XX37.10. I hate writing checks for anything other than a round number. I like writing a check with one or two number(s) followed by a lot of zeroes.

    • A 12 year repayment plan is still pretty quick, especially when it seems like many people never really pay off their mortgage any more. (They just keep moving…)

      And that’s a great point about diversification. Investing only in a single house in a single market is just as much “putting all your eggs in one basket” as investing in a single stock. (Although arguably likely less risky.)

      We are doing other investing as well too — Roths, 401Ks, and non-retirement investing.

  • Pam

    We really have a conundrum. My husband retired early and from that retirement we have a net pension of about $2600. He received a lump sum, which after taxes and charities, is at $22,000, but was originally $45,000. He thinks we have the big amount, but we used it to live on (sending him to college) over the past two years., my shameful secret, but we are investing the $22, 000. We are in our early 50s.

    There is some left over each month–should I try to build back up to the $45, 000, OR should I put the money into our mortgage? The mortgage is at 5.5% and we have nine years to pay on it yet, owing $ 44,775.05. That may not be the payoff amount, though.

    Psychologically I would rather pay off the house, but if the economy gets worse and he loses the pension we will have put all that money into something we may lose anyway.

    Would really appreciate your opinions. Thanks.

    • Hm, I’m not a financial adviser so I can’t give you an expert opinion, but some of the questions I would ask myself when trying to decide are:

      How diversified are you? I think it’s important to be broadly diversified, having investments across a variety of vehicles and sectors.

      How comfortable with risk are you?

      Could one or both of you do some type of work to make extra money?

      If it were me I’d probably be tempted to split the difference, putting a little of the extra each month toward the house, and investing the rest. I’d also talk to my husband about the money having been used to live on and go back to school. He should probably be more involved in your finances too if he didn’t realize that was happening.

      Also, I’m a little confused by the lump sum vs. pension. I can’t quite tell if he got both a lump sum and then pension, or if the pension is money that’s being made somehow off of the lump sum.

  • Hi Jackie,

    Curious to know about your statement “could only ever itemize once” and so your mortgage interest is not tax deductible? I don’t get it. Is there an income hurdle?

    Mortgage interest really helps shield my income b/c I pay 46% marginal tax after California’s state income tax rate. It’s a killer!

    I like having a mortgage and a cash hoard so long as I work. If I know that I will stop working in 3-5 years, I’ll aim to pay it off by then. I like liquidity.

    • The “could only ever itemize once” isn’t about an income hurdle. Instead, it’s based on our past history.

      In all the years I’ve been paying taxes, I have only ever been able to itemize once on Federal taxes because the amount of all of our deductions has almost always been less than the standard deduction. I guess technically I could itemize at any time, but it wouldn’t be beneficial to do so for us ;)

      (In other words, our itemized deductions come out to less than the standard deduction for married filing jointly. It may help to know that our mortgage interest was something like $6,000 last year, and we’re still pretty early on in our mortgage when the interest is highest.)

      It’s probably different in your situation, because living in the bay area you likely have a massive amount of mortgage interest each year, with that amount alone putting you over what the standard deduction would be.

    • And yeah California income tax is killer — my husband used to live there. Ouch.

  • having no mortgage payment frees up lots of money for saving and giving too. The tax benefit really is overrated. And 100% of the time, a paid for home can’t be foreclosed on.

  • “And 100% of the time, a paid for home can’t be foreclosed on.”

    Is not true.

    A home owners association can foreclose on a paid house in some states if they don’t like how you’ve kept up your lawn or if you have missed dues. It has happened and does happen. There was just a horrible story on NPR about it happening to a guy’s family while he was in Iraq (of course, there’s a federal law against foreclosing on active military, but the case isn’t going to court until fall and in the meantime his house has been sold twice and his family is not living there.) His family put their entire savings into the paid off 300K house and it was sold to pay $3,500 in back HOA fees and lawyer fees. If they’d had a mortgage that loss would not have been so bad.

    In some places a paid home can be foreclosed on for unpaid property taxes as well.

    • Ouch! I should have remembered about homes being able to be foreclosed on for unpaid property taxes though, since that’s basically how tax liens work. Here you have to have not paid the taxes for more than 3 years though before proceedings can be started.

  • Shaun

    I’m not a financial expert (just have done a lot of research), but for some paying off ones mortgage may not be the wisest thing to do, as one has to take all of one’s debts into account. Most people have at least one car loan and college loans, so one must calculate the annual average rate of return for any pre-payment (mortgage paydown or refinance). If your average annual rate of return for the pre-payment is larger than your other debts and your investments (almost always the case now), then pre-paying makes sense; otherwise, you should be paying down higher costing debts first.

    Based on the interest and tax tables, a house purchased recently (last 5 years or so) can be a good candidate for a refinance, even if it is slightly under water. Assuming your example of a couple filing jointly and making about $98K, with a 5 year old 30-year 80% to 90% fixed mortgage at around 6% (what was the average in 2006), refinancing the mortgage to 20 years at 4.25% can yield total savings equaling an average annual return of 10% or more, depending on your closing costs and assuming you hold the mortgage for at least another 10 years. This takes into account itemizing ones return, deducting the points over 10 years, the amount of interest paid on the old and new loans, and the difference between the tax deduction for the old and new loans. Calculating this is not easy, as very few of the online calculators are set up to do this and some have errors in their calculations, but it can be done.

    Calculate your particular situation first (all debts and investments), and then decide.

    • I would absolutely agree with paying off higher interest debt first. Refinancing can be a great idea given the right circumstances, especially if it can be done without closing costs or other fees. It really does depend on the individual situation and all the related factors.