Should You Pay Off Your Mortgage Early?

[00:00:00] Speaker A: In this episode, we're going to cover an age old debate when it comes to decisions you make with your money. And that is, should you or should you not pay off your mortgage early? Let's get started. [00:00:10] Speaker B: Let's get some money from new money new problems. It's the new money new problems. Um, podcast. A show for successful professionals searching for the tools they need to navigate financial opportunities and, uh, obstacles they've never seen. Negotiating compensation, purchasing your first investment property. Helping your family with money. The highs and lows of entrepreneurship. New money brings new problems that require new solutions. Join us as we work through them together. I'm Brenton Harrison, and this is the new Money New Problems podcast. [00:00:48] Speaker A: Hello. My name is Brenton Harrison of new Money new problems and your host for the new Money New Problems podcast. We are back in our series talking about homeownership and how you structure things like mortgages, home equity, lines of credit. And this episode is kind of the beginning. Call it like the part a of that little mini series within the series. Now, I will tell you that. And this is actually something we referenced in a LinkedIn post recently. There are very few things in finances as I, uh, age in the field where I would say, you should always do this or you should never do this. And that has really been something that's evolved over time. I think with wisdom, you learn to stop speaking in absolutes. And when it comes to how you pay your mortgage, that's definitely one of those areas where earlier in my career, I was probably pretty adamant about not paying off a mortgage early. But as I've seen more things, I do think there are some scenarios where it can benefit the person, as long as they have an understanding of the pros and cons. Now, I will say that more often than not, I would discourage a person from paying off their mortgage early. And here are some reasons why. Then I'll give you some reasons why a person would pay off their mortgage early. And in the second half of this episode, we're going to share three different tips that you can use if you're trying to pay off your mortgage early without necessarily devoting all of your financial life towards that objective. So, what are some reasons why I typically discourage people from paying off their mortgage early? One of them has to do with a false sense of security to what it means to actually pay off a mortgage early. And false sense of security means that paying off a mortgage early implies to many people that you will not have a payment associated with your house. And if you look at your mortgage statement, m definitely. If you don't use escrow to pay things like property taxes, you are fully aware that what you pay each month is not just your mortgage. You pay your mortgage, the principal and interest that's needed to pay down that debt from a month to month basis. But you also have homeowners insurance that you're required to pay for and also property taxes. And even if you were to pay off that mortgage, that principal and interest payment would go away, but the property taxes and the homeowners insurance would not. So you want to make sure that you have an understanding, when you're paying off a mortgage, of exactly how much it would reduce your expenses, because there are some areas where property taxes and homeowners insurance are a significant portion of that monthly payment. But even if you were to get as much relief as you expected, one of the things that I see people fall into in terms of the trap of not having a mortgage is also a lack of understanding of the fact that as homes age, they typically require more and more upkeep when it comes to maintaining the quality of that home. So even for my clients who have decided to pay off their mortgage early, I encourage them to start a little, you know, in church parlin, like a building fund or, uh, a little slush fund, to make sure that they're not just saying, oh, well, we'll pay for it when it comes. No, you need to have a dedicated portion of your monthly budget that goes towards the upkeep of an older home, which typically increases with time. The next scenario where I'm, um, typically not a fan of somebody paying off their mortgage, is when doing so does not actually save them a, uh, significant percentage of their monthly expenses in terms of what their finances will look like in retirement. And what I mean by that is this. If you are paying off your mortgage and your mortgage is just the lion's share of your monthly expenses that you'll incur during retirement, then there can be a real benefit to doing that because you've left yourself with a reasonable amount that's left over that you can cover through your investments. However, especially for high income earners, your mortgage is something that may be expensive, but you have all other types of things that are added on to your monthly expenses. And when you look at the percentage of those expenses that's taken up by your mortgage, paying it off would not put you in a position where you can reasonably expect to cover what's left over without having a significant investment portfolio. Let me show you what I mean. If you're following on screen let's say that we have someone who has a $2,000 monthly mortgage, but they have $10,000 of monthly expenses, including that mortgage. Now, we're going to assume that they, however they do so, pay off that mortgage early, and that $2,000 is wiped away. And that leaves them with $8,000 of remaining monthly expenses in today's dollars. Now, let's assume that this couple is recently retired, and they have a, uh, combined Social Security payment each month of $5,000 each month. Well, that leaves them with a shortfall of $3,000. That's $36,000 a year. Well, if you remember our episodes where we talk about the 4% rule or the 5% rule, that rule says that whatever you have in your investment account, you need to only live off of four or 5% of it a year to make sure that those funds aren't distinguished. Well, at $36,000 a year of a shortfall that you need to cover through those investments. Even if we're using the 5% rule, that means you'd have to have an investment portfolio of $720,000 to make sure that you can generate $36,000 a year to cover that shortfall with that portfolio. That's a tremendously large investment account, and if you're going to pay off that mortgage and pay extra to do so, I would argue that it may be a better idea to simply put as much money into the market as possible so that you can pursue the balance of that investment portfolio, rather than saving a few years on your mortgage when it's not a significant expense relative to what else you pay for on a monthly basis. Now, comparatively, let's say that this person's expenses are even $2,000 lower. They have a $2,000 mortgage, but they have $8,000 of expenses instead of ten. That means that after they pay off their mortgage, there would be $6,000 that's remaining on their expenses. That $5,000 Social Security payment lowers that shortfall to only $1,000 a month and $12,000 a year. If we're adhering to the 5% rule, this means that unlike the person who had the $3,000 shortfall and had to have a $720,000 investment portfolio to cover it, this person only has to have a $240,000 portfolio to cover it. So this would be a scenario where this person may say, if I pay off that mortgage early, then my guaranteed income sources, combined with not having that payment, may actually put me in a great financial position. But the last reason I'm typically not a, ah, fan of people paying off their mortgage early has to do with the concept called opportunity cost, meaning, what am I giving up by paying extra on this mortgage? And in most cases, what they're giving up is the opportunity to instead put those dollars into the market, which could in many cases, have a better opportunity for a higher return than what you're saving by paying off that mortgage early. Let's assume that we have a person who has a 30 year mortgage for $300,000 and they're paying that mortgage at 6% interest. Now, that means that the mortgage itself has a payment of just about $1,800 a month. But they decide from the beginning they're going to pay an extra $500, which is $2,300 total per month. Now, you can see at the top of this chart, that extra $500 shortens their mortgage repayment by twelve years and four months. So they actually end up paying this mortgage off in 17 years and eight months. And when you look at how much money it saved them, instead of paying $647,000 in total on that original loan of $300,000, they saved just about $160,000 worth of interest. Now, let's compare that to what they would have received if they taken that extra dollar 500 and simply put it in the market, say in an S and P 500 index fund. I'm going to go back and I'm going to start this repayment period in January of 1996, and we're going to have them put $500 a month into the S and P 500, stopping in August of 2013. And I chose this period because it was a particularly rough 17 year stretch for the S and P 500. You can see starting in 1996, that there were losses in this period of negative 9%, negative 12%, almost negative 22%. And in 2008, we all remember a negative 36% loss in the S and P 500. But when you look even in this particularly rough period, that $500 a month, as compared to the $160,000 they saved in interest, they would have gotten about $180,000 by putting that money in the S and P 500. If they had chosen a better period, say 2006 to 2023, that $500 a month would have grown to $308,000, almost double the interest they saved by paying that dollar 500 extra on their mortgage. And you're probably saying, yeah, but that person who paid extra can now take that $1,800, which is way more than $500. And once the mortgage is paid off, they can simply put that money in the market. Well, first I would say if you're saving the $1,800 on the M mortgage and then you're just putting that $1,800 in the market, there's been no relief for you in terms of what's coming out of your pocket every single month, which is a big reason why most people pay off their mortgage in the first place. But let's assume that they did that. Let's take that $1,800 a month and we're going to assume that this person puts that money in the market from September of 2013 to March of 2024. If they started at $0 after their mortgage is paid off, they put that $1,800 aside. Then at the end of March 2024, they would have had about $467,000. But remember, we have to compare this to the person who didn't pay extra on the mortgage. They instead put dollar 500 a month for that 17 years and grew their account to $$180,000. So let's assume that they took that money and just said, after that 17 years, I don't want to put any more money aside. I'm just going to let what I have in the S and P 500 ride with no additional contributions. Between the years of September 2013 to March of 2024, that 179,000 with no additional contributions grows to over $640,000. That's right. By leaving their account alone and not making an additional contribution for over a decade, they still end up with over $150,000 more than the person who decided to use their money to instead pay off their mortgage early. Now, after all of those reasons why somebody would not pay off their mortgage early, what are some scenarios where they would pay off their mortgage early? Well, one of them, in my opinion, is if the plan that you're enacting to pay off this mortgage takes you ten years or less. Now, that ten years is a bit of an arbitrary number, but the thought process that's behind it is when you're paying off your mortgage early and it's still going to take you 15 to 20 years to pay off some 30 year mortgage, that's an amount of time that's lost in the market where, in my opinion, the opportunity cost is too high over 15, 1718 years. I would much rather you have those additional funds in the market in most scenarios. Because in my opinion, if you look back in history, even though that's not a predictor of future returns, the market is going to beat what you're saving by putting those extra dollars towards the mortgage. But in a ten year sprint, the amount of additional money that it costs you is not something that can't be recovered from, or you're at least close enough to that goal to make it make sense. Right. And if I can get this accomplished in a shorter period of time, then that allows me to get back to the market faster. That could be a scenario where it could make sense to you. The second scenario is one that we covered already. If your expenses are meaningfully reduced, if your mortgage is 25%, 33%, 40%, 50% of your monthly expenses, then you could really do some damage by freeing up that mortgage payment and not having it on your expense list. The third scenario, where I think that paying off a mortgage early could make some sense, is if you're doing it for a leverage play from an income perspective or from a career perspective. I was having a conversation about this with a friend recently who's feeling like, hey, you know, I want to have some flexibility in terms of my career choices. I don't want to be at a place where I have to work here, even though I don't want to work here, because I need this amount of money. Well, if you're significantly lowering your expenses, then that can conceivably significantly lower the amount of income that you need to cover those expenses on a monthly basis. So if you're trying to position yourself where you can take advantage of maybe pursuing entrepreneurship or take advantage of being able to take a job because you enjoy it, rather than because you need a certain amount of income, reducing the burden that you feel you have to meet each and every month financially, could do a wonder in terms of just giving you, again, increased flexibility. So if you're listening to those reasons and you're saying, hey, this is something that I want to pursue pretty aggressively, then, hey, maybe it's the right thing for you if you fit one of those things, or maybe just for the peace of mind of not having debt. You know, finances are not just about numbers. There is some peace of mind element to it. I do want to make sure in most cases, though, that someone is not pursuing their peace of mind at the expense of just reasonable financial decision making. So there is a line. But if you feel like you're on the right side of that line and peace of mind is telling you to pay extra, maybe you should pay extra. But if you're listening to this and you're saying, hey, I want to dip my toe in the water, maybe I want to pay a little extra on my mortgage, but I don't want to just have it consume my financial plan. Then after the break, we're going to tell you three things that you can do, two of them very easy to do, the third a bit more extreme, that you should do with caution and under the advisement of a professional. But after the break, we'll tell you those three ways to pay off your mortgage early. [00:14:17] Speaker C: This is the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen. We'll be right back. [00:14:36] Speaker B: Are you wondering what new money problems you might be overlooking in your financial life? If so, we've got great news. We've crafted the new money new problems gap finder to identify potential weaknesses in your finances in areas ranging from budgeting, investments, insurance, and even the threat you, your extended family's finances could pose to your household. Please head to newmoneynewproblems.com gapfinder to complete it today. Again, that's new Moneynewproblems.com gapfinder. To take the assessment m. [00:15:14] Speaker C: You'Re listening to the new Money New Problems podcast. Subscribe now at new Moneynewproblems.com dot. Welcome back. [00:15:25] Speaker A: All right, what are three ways that you can pay off your mortgage early without significantly increasing the amount of funds that you're devoting towards that goal? The first two are really just two different ways to make an extra mortgage payment. Now, when it comes to why you would pay an extra mortgage payment statistics have shown that in some cases, making one extra mortgage payment a year can shave off as many as four to five years from the length of time for your repayment. So on a 30 year loan, you could have it paid off in full within 25 or 26 years just by making that one extra payment. Now, the way that you make that extra payment can take many forms. There are some people who take their monthly mortgage payment. They divide it by twelve, and they simply add that amount onto their monthly payment and have those funds go directly to the principal. You have to make sure when you set up this payment plan with your provider that these funds are going directly to the principal and not interest. Another way of making an extra mortgage payment is to simply just make a lump sum extra mortgage payment. Some people do this at the end of the year. Some people do this when they get their tax refund. But in our scenario of $1,000 mortgage payment, you would simply, in this case, if you got a tax refund for $2,000, take $1,000 of it and put it towards your mortgage payment, it would achieve a similar objective. And the last way people will achieve this objective without greatly changing the structure of how they make their payments each month is they would switch their mortgage payments from monthly to bi weekly. And the reason this works just has to do with a little bit of the quirkiness, with how a calendar is laid out. If you have a mortgage payment, you pay it every month. So you make twelve mortgage payments. Now, if you were to say, I'm going to cut this mortgage payment in half, and instead of paying it once a month, I'm going to pay it twice a month, well, then you would make 24 mortgage payments. Twelve months times two times per month equals 24. That would be called bi monthly payments. I'm, um, making my mortgage payment twice per month. But bi weekly payments, again, means you're paying it every two weeks, and instead of 24 mortgage payments, you end up making 26 mortgage payments because there's 52 weeks in a year, and if you're paying it every two weeks, you end up paying 26 payments. Well, if you do the math, 26 bi weekly payments means that you, at the end of the year, will pay a full mortgage payment more than what you would by making monthly payments. Now, the third and final method that we're going to talk about is a much more radical method. We are going to give you the first half of this method to kind of give you a preview in this episode, we're going to devote an entire method to the strategy itself because this is something that you might see on social media. You might think it's a scam. I would say that it's not a scam. It can definitely work, but it requires a radical transformation of how you do your monthly expenses. And it's not something I would advise you do. Uh, if you're not working with a professional again, we're going to tease out the first part of this strategy on this episode. And that strategy is velocity banking. What velocity banking basically does is it utilizes a home equity line of credit, like we've talked about in previous episodes, to pay down your mortgage. So, for example, if you had a $400,000 mortgage and you had $100,000 line of credit, you would take that $100,000 line of credit and you would pay down that mortgage. So that instead of owing 400,000 on the mortgage, you would owe $300,000 on the mortgage. And you're probably sitting there and thinking, well, how does that make sense? Because if you add in the line of credit, I still owe $400,000 in total. I have not reduced the amount that I owe in full, and you would be correct. But what you have done is, because your mortgage payment does not change from month to month, you have radically increased the amount of principal that is paid off with each subsequent mortgage payment. Let me show you what I mean, and we'll go back to our original example. We have a $300,000 mortgage for 30 years at 6% interest. We're going to assume that it starts in April of 2024. And it's the same mortgage payment that we talked about before the break. It's about $1,800 a month. Now this that you see below this, if you're looking on screen, is what's called an amortization schedule. So it shows you month by month, throughout the course of this 30 year loan, how much principal you're paying with your $1,800 a month, and how much interest you're paying with your $1,800 a month. You can see that in the first month that this mortgage payment is made, the person pays $1,800. But only about dollar 300 of that goes to actually pay down the principal and $1,500 goes towards interest. As a matter of fact, if we started this $300,000 mortgage in April of 2024, you can actually see that it takes over 16 years to pay off a third of that mortgage balance. You would think that if I have a $300,000 loan for 30 years, I should hopefully pay off about $100,000 every ten years. But because of the interest that's due and the way that mortgages work, it actually takes you over half of those 30 years to pay off a third of the mortgage. Now, the thing is, once you've paid off a third, you can actually see on the right hand side that this mortgage balance is now around $200,000. Look at how much of that $1,800 monthly payment is going towards the principal now instead of like $300 like it was before, and now it's almost dollar 800 a month that's going towards the principal. So the premise is, when you have these mortgages, your payment never changes. But over the course of time, more and more of that payment goes to pay down the principal. Less and less goes to pay down the interest. So what you're essentially doing by taking that home equity line of credit and using it to pay down your mortgage is you're basically fast tracking the amount of time it takes to get further in the loan process, where more and more of your monthly payment is going towards the principal. So if you can do that as fast as possible and have a plan for how to pay down the home equity line of credit as well, you will actually see people who use the velocity banking concept who will have a 30 year mortgage that they find a way to pay off in seven to twelve years. Now, again, it is a radical strategy because keep in mind you've paid down your mortgage, but you still have that balance that's remaining on the home equity line of credit. You have not actually reduced the total amount that you pay relative to this property. So in the next episode in this series, when we dedicate the entire episode to velocity banking, we will explain to you how people who utilize this concept put a plan in place to actually pay down that line of credit in a quick manner as well. Now, I know that was a lot, and I know that is a hell of a tease to give you when it's really probably going to be two or three weeks before we get to that second episode. Maybe I can be convinced to kick it up a week earlier, but I hope that that at least introduces the concept in a way that piques your interest if it's something that you think you may want to implement in your own life, but please do not do so until you listen to that episode in full. We'll be back next week with some more financial literacy for you that I hope you find valuable, and I definitely hope to to see you then. [00:22:25] Speaker B: Let's get some money from, um, new money new problems. This was the new money, new Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.