Mortgages

When I was in grad school, an old friend of mine transferred up from San Diego State.  We didn't have classes together, but we hung out: tennis, golf, cards, that kind of thing.  For some reason, I didn't see his place until well into the school year.  When I finally did see the apartment, it was pretty typical for a single, male student in a rent controlled university town.  Dark, dingy, ugly carpet, holes in the walls.  I was used to all that.  However, when I went to use his bathroom, even I was shocked.

The entire toilet bowl was covered in a thick layer of black mold.  And not just the bowl.  It was all over the underside of the toilet seat, behind the seat, and even on the base.  The bathtub?  Just as bad.  Black and orange mold on the tub, on the walls, on the glass doors.  Everywhere.

I had to ask.

"Hey, Nick!  What's up with your bathroom?  It's disgusting!!"

Nick held up his hands and immediately defended himself.

"Whoa, don't blame me!  It was that way when I moved in."

Hi Slash!  Sorry I'm late.  Summer is always a crazy time for me.

"Hey, no problem, Dankwart, glad you could make it."

My pleasure.  Thanks for inviting me.  This barbeque place smells terrific, I haven't eaten all day.  But um...just out of curiosity...why did you invite me?

"What, can't a guy treat one of his best friends to dinner without raising suspicions?"

Well, to be honest, I never thought you actually appreciated my company.  And spending money on me?  Unprecedented.
 

"All right, all right.  I'll come clean.  I'm trying to figure something out, here.  And it's a bit more complicated than the advice I normally ask of you."

How much more complicated?

"It could take hours to sort through it all."

Yikes.  Okay, well then, we'd better get started.  What is the problem you are trying to solve?

"I want to know if I should pay off my mortgage early."

No.  Hey, can I borrow your menu?
 

"How's that?"

Can I borrow your menu?

"No, I mean, did you just tell me not to pay off my mortgage early?"

Yes, I did.  Now, about that menu...

"Wait a minute, Dillweed!  I haven't even told you my financial situation.  We haven't talked about taxes.  You don't know how long I have left on my mortgage, what my debt load is, or a litany of other facts and figures.  How can you answer me so quickly?"

Well, you're right.  There are a whole host of considerations that we haven't discussed, and all of that may factor into your decision.  However, I get asked this question a LOT and it always seems to boil down to just one thing.

"Which is...?"

How to think about your mortgage.  And that can be tricky because there is a lot of conflicting advice out there.  The last time I googled "Should I pay off my mortgage early?" I found a blog from a well respected author and radio host who says:
 

"When people ask me whether or not they should pay off their mortgage, my answer is always, unequivocally YES."

On the other hand, another very respected author and radio host says:
 

"You should have as big a mortgage as you can get and never pay it off."

 

"You're not exactly helping me here."

Well, so if you are wondering what is the better financial decision, my answer is that it is highly likely that you would do better holding onto the mortgage as long as you are a disciplined saver and investor.
 

"Why?"

Because you probably have a pretty low mortgage rate.  Something like 4% or so.  Right?
 

"Yeah."

And I'm guessing your stock/bond allocation is something like 50/50 or 70/30 or 40/60.  Right?
 

"Right."

So you can expect to earn, on average, about 7-8% a year on those investments.  So, by holding onto a mortgage, you are borrowing at 4% and re-investing that money to earn 7-8%.  That's a huge spread compounded over time.  The first author/radio host gives an example of "Joe" who saves $80 K by paying off his mortgage early.  But Joe is not really saving anything so much as foregoing the opportunity to give up $80 K to earn $150 K (or some such).
 

"What about taxes and tax laws changes, and moving, and downsizing and home equity loans and all of that?"

 

Most of that stuff is less important and highly unpredictable.  In my opinion, the differences in the mortgage rate and your expected return on investment is the dominant factor.

"So, the first author/radio host is completely wrong?"

No, I believe he is just making a fundamentally different assumption about his audience.  He assumes his readers and listeners will not save and invest the money that would otherwise go toward paying down the mortgage.  Which, for the average homeowner in the U.S., is probably a decent assumption.  In that case, pay off your mortgage early because that may be your only savings vehicle.

The second author/radio host assumes his audience will save and invest the money and therefore, do better financially by keeping the mortgage and investing elsewhere.  (And that is also my implicit assumption when I answer this question from a purely financial perspective.  Ultimately, I figure my audience can gauge their own ability to save like crazy and invest wisely.)
 

"As simple as that?  Don't pay down the mortgage?  Do what the second author/radio host says and get as big a mortgage as I can and never pay it off?"

 

Well, I wouldn't go that far.  "As big a mortgage as you can" suggests buying as big and expensive a house as you can, and that makes no sense to me at all (financially, morally, psychologically or spiritually).  (I have mentioned that in past blogs.)  And as far as "never pay it off," well, there is some satisfaction in owning your home outright, and that is probably worth something to most people.
 

"Then what are you willing to say?"

Mortgage rates are ridiculously low.  If you are a disciplined saver and investor, don't pay off your mortgage early.
 

Enjoy cheap loans.

 

"Are you two ready to order?"

"Uh...no, we're leaving.  We're uh...vegetarians."