Disclaimer and Warning: If you have credit card debt, this is NOT the article for you. Don't interpret anything in this article as permission to carry credit card debt.
I am an Amazon Affiliate. I will receive a (really, really) extremely small commission if you click on a link and buy the book. See the footbar below for complete details.
I have watched with curiosity as many folks have started or are in the midst of a 7-step program to eliminate all debt and live frugally. I agree with many of these steps and processes especially the mantra that you have to live within your means and prepare for the future. What confounds me is the advise to pay off your mortgage early and as quickly as possible because that is NOT what my rich dad taught me.
My dad taught me many great financial lessons. One of the best is to realize that there will always be people with more money than you have. There will always be people who live a grander lifestyle and that the lifestyle someone is living is not necessarily indicative of their wealth. Financial worth is the sum of your assets less the sum of your debts, not how big your house is or what brand of car you drive. He taught me to be myself around both those who are wealthier than I am and those who are significantly less wealthy than I am, neither to try to impress those with more nor to apologize around those with less. He is a wise man and is rich in not only financial worth, but also in the things that really matter – faith, family, friends, love.
Another of his lessons is that debt is not 100% bad. Debt is what the wealthy call “leverage.” If you can do something better with the cash you would use to pay off the debt, then you should do it. (Again, not talking about credit card debt. Credit card debt is ALWAYS bad.) With mortgage loans at a historic low, there is no better time to keep your mortgage and use your cash for better things.
Before we discuss what the better things are, let's lay out the problems with a paid-for house:
- Your home is a place to live and not necessarily an investment.
- Your personal home (unless you rent out a room) does not provide income.
- Many net worth forms exclude your home equity because it is not considered an “investable asset.”
- You will lose the tax deduction for the interest on your home.
- If you need the cash invested in your home, you will have to sell the house to get your money or take out another mortgage. If the reason you need the cash is due to a catastrophic illness or disability that has caused you to lose your income, you will not qualify for a mortgage.
What you need to do instead:
Prepare for the future and that includes unimaginable disasters.
- Buy good health insurance. Your health can change in a moment. Buy the best insurance you can and that works for your family. A health disaster can last longer and require more than a savings of 6 months living expenses. I saw a Facebook post this week about a family whose child needs a $200,000 brain surgery. One of their prayer requests was that their insurance would pay more than 50% of the cost. They have bad insurance if that is the case. Probably the number one thing to look at when picking health insurance is your maximum out of pocket cost per year. Ours is $10,000 for our family. Do not skimp on health insurance.
- Buy as much disability insurance as you can get. The biggest financial disaster than any family can experience is the complete disability of the main wage earner.
- Buy adequate life insurance on the main wage earner. Also buy enough life insurance on a stay-at-home parent to cover the cost of child care if that person were to die.
- Insure your home for its replacement cost. Insure it for the possible disasters in your area like flooding or earthquakes. I picked up earthquake insurance about 6 months ago because Oklahoma has become a hotbed of seismic activity.
- Have good wills drawn. It's no fun to think about and it can be expensive, but it is necessary.
- If you have done all of the above and still have disposable cash, then invest it. Put the amount you would put toward paying down the mortgage into an S&P 500 index fund. An index fund that you never touch or try to time will most likely outperform the interest you are paying on your mortgage. Or save for the down payment on a second home to use as a rental and let a renter pay the mortgage, taxes and insurance. If you want to work on paying down a mortgage, pay down the mortgage of a second home because that home provides income, whereas your personal home is only income if you sell it. If we have inflation, buy a CD ladder with your cash and celebrate that your house is at 3.75% and gaining in value everyday, while you are making 7% off your cash.
I did not want to dispense financial advise without a significant amount of research and number crunching, so I prepared 5 scenarios to illustrate my point. (Keep in mind there are infinite combinations and permutations of mortgage situations and I could not do them all.) These should illustrate how you can plug in your own numbers for your situation. All of my number crunching spreadsheets and sources are available to print. The first three scenarios cover the last 30 years (1986-2016) and the last two cover the last 10 years (2006-2016).
Scenario 1: A home is purchased in September 1986 with a $120,000 mortgage at the scary rate of 10% (yes, that was the rate for a 30 year mortgage in September 1986). Beginning with the first payment, $500 extra per month is paid on the balance of the mortgage. The home is paid for on April 1, 1997. Beginning on May 1, 1997 $1550 is invested monthly in an S&P 500 index fund. On September 1, 2016 the fund is worth $681,029.19.
Scenario 2: Same purchase and mortgage details. Instead of paying extra toward the mortgage, $500 per month is invested monthly in an S&P 500 index fund. On September 1, 2016, the mortgage is paid in full and the index fund is worth $685,565.85 or $4,536.66 more than scenario 1.
Scenario 2 is not that much more impressive than scenario 1 because interest rates were high (therefore, harder to make more money somewhere else) and the person in scenario 2 failed to refinance once rates become significantly more reasonable.
Scenario 3: Same purchase and mortgage details as 1 and 2, except the mortgage is refinanced in October 1993 at 6.91%. On September 1, 2016 a balance of $52,912.55 remains on the mortgage, but the investor has $827,119.22 in the index fund. This amount is more than enough to either continue the mortgage payments or write a check for the balance and still have $93,177.48 more in the fund than in scenario 1.
Scenario 4: A home is purchased in September 2006 with a $120,000 mortgage at 6.55%. Beginning with the first payment, $500 extra per month is paid on the balance of the mortgage. On September 1, 2016, only 14 payments remain and the balance of the mortgage is $18,585.53.
Scenario 5: Same purchase and mortgage details as scenario 4. Instead of paying extra toward the mortgage, $500 per month is invested monthly in an S&P 500 index fund. On September 1, 2016, a balance of $102,066.47 remains on the mortgage and the fund is worth $95,434.31.
What do both scenario 4 and 5 investors need to do? Refinance the mortgage!!
Looking at scenarios 4 and 5, it is tempting to think 4 is better because the results are more immediate. It is easier to check off the mortgage balance every month and be proud of the progress. It is harder to put money in an investment month after month, never pull it out regardless of the market performance and wait for what has historically always happened: an investment that beats inflation. I understand it is counter-intuitive. While there are never any guarantees, the smarter thing is to invest your cash and treat your home like a place to live. It does not require searching to find financial experts who agree. Without any effort, I found two concurring opinions in the two newspapers I read daily.
Suzanne Wheeler, a certified financial transitionist, a financial planner who aids clients in difficult financial situations, says, “When markets decline for a period of time, we need to revisit the long-term plan and remind ourselves this is a cycle, and it will eventually stabilize.” Tulsa World, September 16, 2016
“‘I consider mortgage debt ‘good debt,'” says Delvin Joyce, managing director at Prudential Financial. “‘If you're a retiree, or soon to be, your kids are likely out of the home, so your home may be one of your only tax shelters.'” USA Today, “3 bills to pay off before you retire,” September 15, 2016
Way back in 1991, just after I married, I read an article by Jane Bryant Quinn. There was a 1-800 number to call and order her book. Several weeks later it showed up in my mailbox. I read and marked the book cover to cover and, after my Dad's wisdom and advise, her book formed most of my financial plans and philosophies. I have kept the book for sentimentality, if nothing else. I checked back to see what she said in 1991. Her book gave positive reasons to pay down a mortgage and also some negatives. Interest rates were high in 1991, so there were many more reasons to consider paying down a mortgage than there are now. On page 821 of the 1991 edition of her book “Making the Most of Your Money” (updated in 2009) she says, “If you are definitely not rolling in money, hang on to your mortgage. If you pay off the loan, your precious liquidity will be lost. You'll be house rich but cash poor. You might even be forced to sell the house just to get your capital back out.” Her current book is called, “How to Make Your Money Last: The Indispensible Retirement Guide” I love her easy to understand, practical way of explaining financial planning and options. Another book I like is “Your Money Ratios – 8 Simple Tools for Financial Security at Every Stage of Life” by Charles Farrell, JD, LLM.
Ultimately the decision of whether to pay down your mortgage or use the money for other things is a personal one. I am 25 years into marriage, my children are almost grown and retirement is still almost 20 years off. I am happy with our decision to keep a mortgage, be extremely well-insured, invest in low cost mutual funds and rental property and the lifestyle we have lived.
My last message is to remember that life is about way more than creating wealth. Enjoy your children and give them experiences while they are home. Young families get sick of hearing people tell them that time is short. It did not feel short when I was in the grocery store with my small children either. I don't want that experience back. The experiences I would love to do again are trips to the beach and the mountains and cruising on a ship, days at sporting events, the fun of Christmas morning with little children. Whether you believe it or not, your children will one day get their drivers licenses, graduate from high school and leave your nest. They will come home and some of those days will be like they never left, but your children will never again be as available as they were when they were young. We took two trips this past summer without at least one of our children. The oldest had an internship and could not join us on either trip. The middle child had a conflict with a camp for one of our trips. We still had fun, but it is not exactly the same.
I have also had an unfortunate front-row seat to a number of tragic disasters. I have been to the funerals for 5 people who were killed in a plane crash, four of them from one family. I had a friend who collapsed on her bathroom floor one morning from an abdominal aneurysm and died by that evening. Both my husband and I have a grandfather we never met because they died suddenly when our parent was a teenager. I've talked to the family members left behind in these unimaginable and completely without warning situations and not one of them ever mentioned whether the mortgage of the deceased was paid. I've heard about the necessity of wills and life insurance. I've heard many stories and memories. As long as there is a source of income to pay the mortgage until it can be sold, the mortgage is not an issue. All of the survivors of these people would give any amount of money to have another day with their loved one.
You will eventually pay off your mortgage. It will happen, but don't do it at the expense of preparation for disasters that a paid-for mortgage won't help that much or at the expense of experiences with your children. Take them to the beach. Take them to the mountains. Take them fishing. Take them to the zoo. Take them to the amusement park. Take them to the game. When they are grown, these are the memories that will continue to bond you together.
I have spent many hours of trepidation on this article because I know it crosses a current conventional wisdom. I have added, subtracted, checked, re-checked and re-checked again all of my numbers. If you find an error of some significance ($1000 or more), please alert me. Amortization tables may produce amounts that are insignificantly different that mine. I also don't mean my article to be insulting. If you read it and want to continue paying down your mortgage, that is A-OK with me. The main purpose of my article, no matter your decision, is to urge you to never allow only one source to be your guide (except Jesus, of course….). Read MANY books, magazines, newspapers and blogs with financial advise and construct a plan to is tailored to your family.