Why Paying Off Your Mortgage Fast is Only Sometimes a Good Idea

In 2014, The American Community Survey revealed an alarming statistic: Of all mortgage-paying homeowners in the U.S., the median home loan debt was $122,000. Even worse, the study showed that more than 50% of mortgage-paying home-owners had 2/3 or more to pay of their home’s value.

Little surprise, then, that a lot of people want to know how to pay off their mortgage.

But while a home purchase ratchets up debt, it’s also likely the single biggest investment you’ll make in your entire life.

Given the complicated balance of debt and asset that homes account for, I sat down with financial guru Dennis Miller to chat about a very sticky topic: Should we be paying off our mortgages now, or dealing with interest over the life of a 15 or 30-year mortgage?

Is it worth paying off a mortgage as soon as possible? Or even just paying a little extra each month?

Let’s start with the big picture. If an investor has a $100,000 investment portfolio, and has $100,000 in debt, their net worth is ZERO. I’m 78 years old and my experience, along with my peers, is that we really didn’t begin to accumulate wealth until we were debt-free.

Debt is renting other people’s money, and the rent is expensive. If you are borrowing to go into a business you know and understand, your money should work for you. The average working person who says they can invest and earn more money than they pay in interest is naïve. Banks make money on the differential, called the spread. If they borrow at 2% and lend at 4%, their profit is the spread—assuming the borrower does not default, which is always a risk. 

Back to home ownership, now that I’ve spelled out the interest game. I like to start by asking people this question: How much is your mortgage interest? Let’s assume they say 4%. Then the question becomes: “Can you guarantee that you will earn more than 4% after taxes in your investment portfolio for the next 20-30 years?”  Reducing interest cost is a no-risk guaranteed return.

Paying off your mortgage is both a financial and emotional decision. I can assure you that you will sleep better knowing you have no mortgage. I have never met anyone who paid off their mortgage who regretted it. 

But how does building equity in a home help someone build wealth? How can they use homeowner’s equity?

The rule of thumb is you should have enough money to live anywhere from 3-6 months (your emergency fund). When you pay off, or pay down, your mortgage, your net worth increases. Banks make it easy to have a home equity line of credit so you can borrow in case of a true emergency.

I confess to being the spender in my family for too many years. I learned I needed to make sure money was not sitting there burning a hole in my pocket. Whenever I had extra money, I used it to pay down my mortgage to keep me from doing something stupid like buying a new car when the old one worked just fine.

It looks like the Federal Reserve is going to do a couple more rate hikes this year. Does this change whether or not someone should pay off a mortgage?

Not in the least. Remember: When you are no longer a debtor, you can become a lender. That remains true regardless of interest rates.

I recently wrote an article about Fed rate hikes, which you referenced in your question. In that article, I took an example of a couple with a $200,000 mortgage. Their payments were a little over $1,000 per month. Over the life of the mortgage, they would pay almost $165,000 in interest. But that interest payment could be much higher if the Fed raises rates. Now, if that couple pays off their mortgage sooner rather than later, think of the investments they could make with that $165,000+. They could expand their portfolio or invest in higher-interest CDs, for example.

Is there any good reason why someone should not try to pay off their mortgage?

Yes, there is. Borrowing to go into a business you know and understand fits that bill. 

Here’s what I mean: In the days when financial gurus talked about using “other people’s money,” they were generally referencing buying rental property and having it appreciate while the owner collected rent checks. This was investment in a property that had a mortgage, but while mortgage payments were being made (often covered by rent checks), the property appreciated in value. The renters ultimately paid off the mortgage and the owner was able to collect rent checks that were almost completely profit.

Owning rental property is a time-consuming business, it is not passive income. Landlords lament that today’s tenants know exactly how long they can live rent-free before they can legally evict them. And there are other considerations: How much equity do you need to pay the real estate commission when you sell? How expensive is it if a tenant trashes YOUR property? Don’t underestimate the “business you know and understand.”

Is there a strategy you recommend for someone who wants to pay off their mortgage?

Yes. I had a mentor suggest this strategy to me and it literally changed my life:

Print out a monthly mortgage amortization schedule for your entire mortgage. In the example we used in the article above, the payment was $1,013.37 per month. The couple’s first monthly payment included $750 in interest. It took 15 years for half of their payment to be applied to principal. You are not building much equity when the bulk of your monthly payment goes to interest.

I was shocked when I discovered that. At the time, I was paid a salary and quarterly bonus. I started taking half of the bonus and applying it to the principal. In the first year, I took something like 5 years off my mortgage. 

Also, many people are making bi-weekly payments instead of monthly. That can knock years off your mortgage, too.

The first goal is to make sure the bulk of your mortgage payment is going to equity, not interest.    

As I mentioned earlier, a home is usually the biggest asset a person has. Should that change the way people think about their investment portfolio and asset allocation?

I urge people to think in terms of net worth. If you have equity in your home, it should hold its value—assuming you are in a decent neighborhood and keep your property in good shape. I guarantee you will sleep better not having to worry about a mortgage payment. I know many retirees who sold their big home after the nest was empty, downsized, and put the difference into investments. That is now providing for their retirement.

Before we go, I want to ask you about something I read earlier this year: There are more renters than homeowners in several of the major cities. Now that we’ve talked about paying off a mortgage, is it even worth thinking about with home prices as high they are in metropolitan areas right now?

There are times renting makes more sense. If you don’t plan on living in a home very long, you may want to rent. 

But keep in mind that whether you rent or own, you will pay the cost of home ownership. Either that means building equity yourself, or paying off a landlord’s mortgage. Over the long haul, having a home paid for is eliminating one huge monthly check. If you always rent, that monthly check is a constant.

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Learn more about Dennis (Miller on the Money), sign up for his free newsletter, and get his free retirement report by visiting Miller on the Money online.

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