Today’s article is on my analysis of the question: Should I pay-off my mortgage early?

Full disclosure; as I embark on summarizing my analysis of above question, I may have suffered from confirmation bias.  The bias stems from the fact that I hate debt. I do not find it appealing nor comfortable to my mental well-being. I may therefore have subconsciously over indexed on evidence supporting the idea that it makes total sense to pay off mortgage as soon as one possibly can.

Brief background

For the purchase of my current primary house, I made a 20 % down-payment and took on a 7/1 ARM loan with interest-rate of 3.5 %. 7/1 ARM loan was taken under the assumption that either of the following two scenarios will play out (a) I would completely pay-off my loan within 7 years (my bias playing a key role in this decision)  or (b) We would move out to greener-pastures, and therefore will end up not living in this house for upwards of 7 years.

As time has gone by we have developed a liking to our small town and can see ourselves living in the same house for a long-time to come. Scenario (a) therefore seems to be more and more likely.

Why pay off mortgage early?

For starters, several of big-wigs of personal finance industry have at some point in time recommend paying off mortgage:

• Suze Orman, in The Laws of Money: “You cannot live in a tax return. You cannot live in a stock certificate. You live in your home“
• Dave Ramsey, in The Total Money Makeover: “Prepay your mortgage if you can“
• Vicki Robin and Joe Dominquez in, Your Money or Your Life: “Pay off your mortgage as quickly as possible“

Below is a compendium of my reasons to pay off mortgage early.

1. it’s personal. Some people (myself included) just do not like debt. Teresa Ghilarducci put it best in the forbes article titled, Should I pay off my mortgage?, “there are two sides to the interest rate – the getting side and the paying side. You want to be on the getting side“
2. guarantee of returns matching the home loan, in our case 3.5 %. In the current environment, try finding a vehicle that guarantees risk-free return of 3.5 %.  In dollar terms, paying off my mortgage in 7 years, would save a approx. $304,000 in interest payments over the 30 year life of the loan (assuming the rate stays at 3.5 %). This amounts to approx. $10K in savings per year.
3.  the standard deductions for a married couple filing jointly is now $24,400. Unless one is running a small-business with lots of deductible expenses, it is increasingly difficult to have itemized deductions, which include mortgage interest deductions, that can beat the standard deductions. This is especially true with the cap on mortgage interest deductions.
4. market cycle. We are now in the 11th year of bull markets for U.S. stocks. It should not take a lot of imagination to conclude that the upcoming decade is not going to be anything like the decade past, and expecting real-returns upwards of 5 % from equity markets is going to be a tall ask, not withstanding major market corrections along the way.
5. more money for household. A huge chunk of monthly fixed expense is taken care off, once the mortgage is paid off. Sure, there are home-related expenses such as maintenance, taxes, insurance, but these pale in comparison to mortgage.

Why not to pay off mortgage early?

Based  purely on math and logic, it makes sense to keep mortgage as long as possible. Lets dig further

• the power of leverage. In an environment of rising home prices, leverage in the form of a mortgage can bootstrap ones returns on investment.
• inflation. Having mortgage in an inflationary environment works wonders. Even with mild inflation of say 5 %, the burden of fixed-rate mortgage becomes less so relative to other expenses. A 10 year 5 % inflationary environment would deflate the value of a dollar bill by about 62 %. On the other hand, the dollar in 10 years would still pay the same amount of mortgage in 10 years.
• opportunity cost. the money not paid back to bank is available for more lucrative investment opportunities. The returns on these investments is the opportunity cost for paying off the mortgage
• asset diversification. Paying off mortgage can make you house rich and cash poor. Not a great situation to be in when faced with short-term financial hiccups such as job loss, or costly home repair or large medical bills.

Middle Ground

When it comes to answering this question for myself, I am in a situation where the heart says pay it off already, where as the mind says, its not a practical path to sustainable wealth (motto of my blog).  In any case, I feel that if one is in a position to go either ways on the question of the moment, it is a no loss situation.

However, I want to note that even math would support paying off mortgage if

• One carrying an adjustable rate loan (as I am) and the rates start edging upwards
• One does not intend to make money work for you. Not a good idea to keep mortgage and take the available cash to spend on (unnecessary) consumer goods
• One is approaching retirement

My middle ground on this question is,

1. Pay extra monthly mortgage, to reduce the 30 year loan term to effectively 15 years.
2. Continue aggressive savings (and investing approach) until (a) liquid net-worth is at least 2X debt, and (b) Cash assets can cover 2 years of expenses
3. Keep an eye on the interest rates as we approach the 7-year time period for rate adjustments.
   1. Should interest rates edge upwards of 3.5 %,  and conditions in bullet 2 are met, pay off the entire mortgage in lump sum.
   2. Should interest rates remain low (or I am unable to meet conditions in bullet 2), refinance to the best available 30 year rate and continue paying extra monthly payments.

While not necessary sound financially, I simply love the idea of being debt free and following the middle ground approach, I hope to never be in a house rich cash poor situation, while still aiming for a debt free future with money always working for me.

Video/Book/Article/Audio for the Week

A few suggestions from this weeks reading/watching/listening:

• Farnam Street posdcast inteview with Daniel Kahneman: A few key take aways for me were (a) automate decision making and follow rules based investing approach (b) keep a decision journal and revisit to take stock of how those decisions turned out, good or bad (c) negotiation is not about trying to convince the other party of ones own view, rather it is about trying to understand them.
• Netflix Docuseries, The Royal House of Windsor: fascinating peak into the lives of the only surviving royal dynasty in the modern age.
• The latest memo from the legendary investor, Howard Marks, titled Mysterious:  Howard Marks take on the strange world of negative interest rates.