133R | Should You Invest Or Pay Off Your Mortgage?

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pay off mortgage or invest
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Brad and Jonathan discuss a burning question in the FI community, a new budget experiment, and an update on Playing with FIRE. 

You Need A Budget Experiment

Jonathan and his wife have decided to give You Need A Budget a try. Although they have no consumer debt and maintain an aggressive savings rate, the luxury of not living paycheck to paycheck means that the low-level lifestyle inflation happens. As a self-proclaimed spender, Jonathan claims that his natural state is to find things to buy.

Jonathan’s wife is really interested in finding a way to better understand where every penny goes. The family used to use Mint for tracking their spending as they paid down debt, but it is not really designed for budgeting out your money.

Several members of the FI community have raved about You Need a Budget (YNAB). With that recommendation, Jonathan and his wife have decided to give it a try. Although the subscription is $84/year, it seems to be worth a try.

If something allows you to create a plan for your money, then I think it might actually be worth it.

The couple will be experimenting with YNAB for the next one to three months. Stay tuned for how it goes.

Related: My Favorite Budgeting Software: YNAB Review

Airbnb With Zeona

Zeona provided another example that the path to FI is not linear. With her adventurous spirit, she created an experimental lifestyle that paid off in the long term. One of the biggest inflection points for her was when she had to ask for $144,000 from an investor to expand her Airbnb business.

She had to get creative.

Zeona told us that the worst thing that could happen is that the potential investor said no. And that is completely true!

Hard money lenders are out there, they are just waiting for the right opportunity to invest. In order to find a hard money lender for your real estate ventures, you need to arm yourself with the right information and crunch the numbers of several deals. Once you find a good deal, then you’ll have a decent shot of finding funding. It is simply a limiting belief to think that you cannot make a real estate deal happen if that is what you want to do.

Each of us has a limiting belief that holds us back.

How would you reframe your thing that you say you can’t do?

In Brad’s example, one of his limiting beliefs is that he cannot take family vacations during the school year. However, with just 15 seconds of thought, he was able to come up with some alternatives to pursue.

Are you holding yourself back by refusing to ask the right questions? The questions that you allow yourself to ask can dictate your future. Think about your limiting beliefs, can you change your frame of mind?

Listen to the whole episode with Zeona here.

Pay Off Your Mortgage Or Invest

Ariel came on the show to share her spreadsheet that helped her find an answer to this daunting question. The spreadsheet will be sent out in through the ChooseFI email newsletter next week.

Ariel’s Path to FI

Ariel and her husband graduated from college without any student loans, so they have been able to start saving from a young age.

Around two years ago, she was researching ways to make extra money. However, she had an 18-month-old at the time and realized that a big side hustle was not going to work for her. During the search real estate had piqued her interest. She found Bigger Pockets, then Bigger Pockets Money and finally ChooseFI.

Quickly, she realized that FI was a real option for her family. She knew that they needed to do something other than save their money into something better than a savings account in order to make that happen.

On her journey towards FI, she has found a series of life hacks that have helped to lower their expenses. She teaches a paid group fitness class for a free gym membership, cuts her family’s hair, bought a gel nail lamp to cut down on manicure costs, and starting going to ALDI. With those seemingly small hacks, she has been able to put around $500 of space into her life each month.

My life is no different but I’m saving money.

As a family, they have decided to prioritize the time they have with their little ones. Instead of rushing to FI in seven short years, they will spend more time at home while their boys are young. Her husband has moved to part-time work and she may or may not go back to work part-time when their kids hit school age.

The next decision was what to do with this extra money?

Pay Down Mortgage Or Invest Spreadsheet

Ariel came from a Dave Ramsey approach. With baby steps one through seven.

  1. Save $1,000
  2. Pay down all debt except house using the snowball method
  3. Save 3-6 months of expenses for a fully funded emergency fund
  4. Invest 15% of household income into retirement investments
  5. Save for your children’s college fund
  6. Pay off home early
  7. Build wealth and give

Both Ariel and Jonathan agree that steps four through seven are “no man’s land.” At that point, you have choices. You can follow the Ramsey steps exactly or create a better way.

With her love of spreadsheets, Ariel created a way to decide whether or not paying off her mortgage early made sense.

Ariel and her husband bought their house for $310,000 with 20% down. The 30-year mortgage with a 4% interest rate would bring their total interest payments to $178,000 over the life of the loan. For a total cost of $426,000. With that high number, Ariel knew that they wanted to do something better than that.

With an extra $500 a month to spend on either the mortgage or investments, she made some calculations. If she put the extra money towards the mortgage, then they would bring down their total interest payments to $93,000 and pay off their mortgage at 203 months.

Next, she calculated the investment route. If they put $500 a month into VTSAX at a 6% return, then it would only take 182 months to earn enough money to pay off the mortgage which amounts to a savings of $36,000. Of course, the returns of the VTSAX are not guaranteed to be 6%.

Ariel chose to put her extra $500 into VTSAX instead of extra mortgage payments. What will the numbers say for you? Wait for the newsletter with the spreadsheet to find out!

Related Article: Should You Pay Off Your Mortgage Or Invest

Playing With FIRE Update

The documentary tour is spreading across the country. Brad and Jonathan will be hosting a showing in Richmond, VA at the Byrd Theather on July 19th. With 600 tickets up for grabs, everyone is invited. Our hosts will be giving a short introduction to FIRE. Head over to Tugg to grab your tickets.

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Related Episodes:

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26 thoughts on “133R | Should You Invest Or Pay Off Your Mortgage?”

  1. I think there are major tax implications of Ariel’s plan that needs some consideration. Without seeing the spreadsheet it is hard to determine if this route is viable. If the capital gains pushes someone into a new income bracket then it might not be the best approach.

      • Robin and Christian raise the question I have been wondering also. Once you re-invest that money into a low cost index fund, and have enough to pay off the mortgage, how much do capital gains taxes dent that pot of money? Would love to hear you talk this through on a future episode. Thank you!

      • Based on the house price and the mortgage rate difference between 15 and is 30 years, put the extra 500/mo and turn the mortgage into 15 years seems to be a good alternative as well. Directly, the term is cut from 360 into 180mo, which is slightly better than 182 mo, and you take the advantage of mortgage deduction (if available) and accumulate equity quicker.

  2. You didn’t factor in capital gains due when using the proceeds from VTSAX to pay off the mortgage. It gets even more complicated when you factor in the tax deduction for mortgage interest.

    • The Capital gains tax is a great point. worth circling back to on a future episode – Thanks! the mortgage interest deduction might be as well although with the standard deduction at 24K currently – it’s likely a moot point in this case and probably for many others- thanks for weighing in

    • A Roth IRA would make capital gains tax a moot point. That’s $500 a month at current max in 2019. If you withdraw that to pay off your mortgage…no taxes. The question is when you get that much in there, will you do it? Will you withdraw or run the math on your gains and keep it in there?

  3. That’s a calculus I’ve struggled with myself, but I admit the idea of putting the money into investments and paying off at the end, thereby gaining investing returns that eventually are used to pay off the mortgage anyway, hadn’t occurred to me. But I have a 15-year mortgage and am paying just enough extra that it should be paid off or pretty close by the time I FIRE (and if not I can use some of those investment returns to pay the rest off before I FIRE anyway, so kind of a hybrid approach). Interesting food for thought!

  4. Yeah not to beat a dead horse, but I immediately thought about the capital gains in this plan. I’m guessing the last year of the VTSAX growth would be subject to short term capital gains. This would make it difficult to do this plan and have a true large amount of savings. Also the emotional piece of watching your house balance go down is amazing to your motivation.

  5. Reframing as “What would you love to do but shoot down; how do I do x; what would it take to make that happen” is great.

    Interesting conversation about pre-paying the mortgage. Dave would say only do a 15 year mortgage, not a 30 year, so I wonder about her results using the 15 year numbers–she’d save even more on interest. Obviously, as you said, the wild card here is what percentage are you going to get on VTSAX and I would really like an update when you add in the capital gains.

  6. Good information. Seems a little complicated. Plus the sooner the house is paid off, the lower your monthly fixed costs and the lower FI number you need. I am a big fan of getting rid of debt in my life. Working on my student loans and then my mortgage.

  7. I was hoping to have the spreadsheet included in a link for others to work with and test out the numbers for everybody’s individual circumstance.

  8. Hi!

    Awesome episode! I love that you had someone on who could put some math to this “taboo” topic.

    For another perspective, here is some math behind the “pay off the mortgage early” camp:

    VTSAX vs MORTGAGE PAY OFF

    We have 22 years left on a 3.875% mortgage. We owe about $212k, and our monthly P&I payment is $1,160/month.

    At first glance, our rate is less than the “4% rule of thumb”, and much l less than market average 6-8%, so it would seem obvious that VTSAX is the winner…

    But wait! What game are we playing? What metric determines the winner?

    If the goal is to have the highest net worth, then VTSAX wins. However, if the goal is to reach FIRE as quickly as possible then the picture isn’t so clear.

    The problem lies in the mandatory principal payment. That payment increases my net worth, but it does not advance me any quicker to financial Independence unless I wait the 22 years until the mortgage is paid off. That’s too long!

    If we keep the mortgage we will need to save (per the 4% rule), an additional $1,160 x 12 x 25 = $348,000 to cover the mortgage payment on our $212,000 loan.

    Thus I can reduce the amount I need to save for retirement by $136,000 by paying off the mortgage early!!!

    Since saving money takes time, this will clearly get me there faster!

    Another consideration is taxes. if you have to pull out investment income to cover a mortgage payment, that will count as income on your tax return. This will raise your tax bracket or lower the amount you can roll over from a traditional IRA to a Roth IRA in a Roth ladder.

    More taxes = more expenses = larger required net worth pet the 4% rule.

    Everyone’s situation is different, and I understand there is a case to be made for the option that will give you the higher net worth in the end. However, my goal is to get to FIRE as fast as possible so I can spend time with my kids before they grow up. I have decided to pay off my mortgage.

    Thanks!
    Mr. DS

  9. Rule of thumb: if the investment return is higher than the mortgage rate then it LOOKS better to invest. Of course, there are some caveats: equity returns are volatile, tax implications, i.e., capital gains as mentioned above but also dividend income to be taxed along the way.
    Back in the old days, there was also the tax deductibility of mortgage interest, but that has effectively gone away for most taxpayers.
    But I should say, kudos to you for using a modest 6% investment return. I’ve seen some other blogs where they use 9%+ and then it’s pretty much a no-brainer to invest. 6% is a reasonable expected return estimate even with today’s lofty equity valuations!

  10. Listened to the podcast and loved the idea until I made my own spreadsheet to see the result. I currently have a newly refinanced 15 year mortgage for $260k at 3.875%. If I invested $500/month and averaged a 6% annual return, here is my result: The investment balance would exceed the remaining mortgage balance at month 127, cutting about 53 months off and saving $7,719.08 in interest. The total return on the investment would be $25,792.63 which would be taxable at $20,000 for long-term capital gains and $5,000 at short-term capital gains. This extra $26k of income and capital gains taxes could end up costing almost as much in taxes as the $7,719.08 that I saved in interest to pay it off early. I’m not a pro and maybe my calculations are off, but this doesn’t seem as attractive an idea as it did to start with.

    Now using this calculator (http://www.interest.com/mortgage/calculators/mortgage-calculator/), I found out that paying an extra $500/month toward principal would pay off the mortgage in month 132, but would save a whopping $22,993.34 in interest with zero tax implications. Again, maybe I did something wrong here, but it seems paying down the loan as you go and avoiding extra interest from accruing is the way to go. Did I make a mistake or did the podcast give some very poor advice?

  11. I have first-hand experience regarding this matter as I was able to pay off a 30-year mortgage in 9 years by doing something similar back in 2007. I’m a huge fan of using spreadsheets and especially Excel. Kudos to you guys for discussing this topic.
    My two cents- I’m a believer in establishing good, simple habit patterns to manage debt when it has to be incurred- like the purchase of a house. For that reason, I’d always choose the known return (savings) on paying the mortgage off. Using VTSAX as the example, it’s just too complicated- too many variables you have to account for. Tax implications, capital gains, sequence of returns, ability to stick to the plan, managing a future payout without seeing the benefit now, AND the fact that while you’re accumulating the balance in VTSAX to pay the mortgage, you’re continuing to pay the highest % of interest in your payment. You’re paying the highest interest while you’re saving for a future payout based on an estimated return.
    Remember that the highest amount of interest you’ll pay in your mortgage is the first payment you make after the loan closes.
    I had a spreadsheet that tracked my actual payments and a mirror for “What if?” With that sheet, I could immediately see the benefit of adding $X to my payment. The motivation provided when you see that $(estimate here) extra this month will take (estimate here) months of payments away will be a driving force for those who wish to reach FI.

  12. Love the comments here and great discussion. I’m currently doing a hybrid approach like BC Kowalski above.
    – I agree, the target you are shooting for in an aftertax investment account is = “mortgage payoff + expected capital gains”. That is a tricky bit of calculus but should be excel-able.
    – There is some psychology to this. I’m excited about getting better returns in the market than “locking in” paydown on my loan until I think about it in reverse. Ask yourself: “Assume your house is paid off, would you be willing to take out a loan at 4% in order to invest in market that might get 6%? Why or why note?” For me, I’m less excited about it when phrased like that.
    – I think there is a role for evaluating the SIZE of the mortgage relative to your household annual savings rate (annual after tax income * %saved). If your mortgage is more than 5x your savings rate, you probably have the time horizon to invest rather than pay down. If your mortgage is less than 2x, you probably should just wipe it out rather than risk market volatility and short-term capital gains taxes. For me, my mortgage represents 3-4x my annual savings rate, hence the hybrid approach. I’m targeting to have my 30 year fixed paid off over 12 years.
    – I strongly believe you should not carry a mortgage in retirement. Extra payments should target a payoff by your FI/RE date.

  13. Hi Brad, Jonathan and fellow FI’ers!

    My fiance and I listened to this podcast and had an ‘aha’ moment for paying down mortgages early. In our case, we own two rental properties we purchased this year, which combined cash flow $633 per month after mortgage and all expenses are paid. We ran a scenario investing this $633 per month into an index fund at Vanguard assuming with a 6% return, and determined that we could have BOTH rental houses paid off in about 13 years (vs. 30 years). We factored in capital gains as well (we’ll have to pay about 6 months of extra payments to cover this, but it’s definitely worth it!). This will save us about $250,000 in interest and 17 YEARS of payments.

    The beauty of doing this for rental properties is twofold – not only is the renter paying the mortgage for us, the additional profit is being used as a powerful tool to save on interest and reach FI sooner. THANK YOU so much for this podcast Brad and Jonathan, and keep up the great work!

    Kari

  14. For what’s it worth, our story is very similar to Ariel except we took the early payoff path. We came from the Dave Ramsey camp, my wife stumbled upon ChooseFI episode 5 in early 2018 and passed it over to me. We have been hooked on ChooseFI ever since! I had previously read JD Roth, MMM, Simple Dollar, and others but none resonated with me as strongly as ChooseFI. Brad & Jonathan truly ignited our FIRE journey 🙂

    Anyways, when we found ChooseFI we were just over a year into our early mortgage payoff plans. Despite the potential math of payoff vs invest we decided to stayed committed to the payoff plan. As of today, we are now inside of 6 months of paying it off. Now are now staring down the barrel of having 25 years of mortgage payments cancelled out by our very aggressive prepayments. The excitement is building!

    The satisfaction and emotional security of being completely debt free forever plus for us avoiding almost $95k in the 300+ interest payments is good enough for us! Outside of the math, having this lofty goal as family certainly helped us accomplish it much quicker than we originally expected.

    We have continued to increase our savings rate (not just the extra payments) and plan to use a fair portion of the regular mortgage payment + our extra principal payments to continue to drive towards our FI goals. We do however plan to relax some because the engines have been running very hot for the last 3 years to kill this mortgage.

    Here’s the spreadsheet I have used for the last few years to track our early payment progress.
    It is a great tool to quickly visualize how extra payments can impact your payoff.
    http://www.tvmcalcs.com/uploads/spreadsheets/Amortization%20Schedule%20With%20Extra%20Payments.xlsx

  15. I enjoyed the podcast, but honestly this whole scenario made zero sense to me. It’s way overthinking the core matter and has too many variables to account for, market return and capital gains taxes being the two biggest.

    As a 44 y/o who hasn’t had a mortgage payment in 8 years, I can tell that anyone who ever had a paid for home never regretted it. The peace of mind alone makes all of the what if’s and calculations pointless. I can appreciate the math, but one thing you can’t account for is risk. My advice to anyone who is sitting on the fence of whether to pay off the mortgage or not is to DO IT if you can. I don’t agree with Dave Ramsey on everything but one thing he spot on about is this, “if you don’t like having paid off mortgage you can always get another one”.

  16. Unless I’m missing something, this is an example of a win in one objective having potential detrimental effects on an unrelated future objective if looked at in a vacuum. I recently considered a similar solution for my family. With 3 kids age 15, 12, and 6, what convinced me otherwise was that the mortgage payoff savings balance in a taxable index fund would count against me when qualifying for student aid (FAFSA) years from now. Home equity in a primary residence (paying mortgage early) doesn’t.

  17. I advocate for this approach on the Bogleheads forum. (There are much more in depth conversations there on this topic if you’re interested in more.) Investing the money is better than paying down the mortgage immediately because of:

    1) Liquidity – If you simply pay DOWN the mortgage, you’re locking up the money into your house. You don’t get the benefit of improved cash flow until the house is actually paid OFF. If you invest, and an emergency happens, you could always defer your pay down plan and use the investments to address your emergency.

    2) Better Returns – When you pay down the mortgage, your return is the interest rate on the note. VTSAX has a better long-term expected return (better than 3-4%).

    3) Flexibility – Once you put the money into your house, you can’t get it back out without refinancing. You could always choose to stop the investment approach and put all the proceeds into a pay down, even if you’re not done. So in the case of something like FAFSA, nothing stops you from restructuring your finances. (The FAFSA issue is debatable, however. Someone with the assets to be at FI by the time the kids are college age will already have some qualification issues. Also, some colleges do count home equity.)

    I have followed this plan, and now have a principal balance of ~$200,000 on my 3% mortgage, and ~$200,000 in a taxable brokerage account. But now I’m hesitating. The reasons I listed above argue against actually paying off the mortgage.

    Capital gains isn’t a big deal. You just have to account for it when accumulating funds. In fact, earning the money in the form of capital gains is an advantage versus earning the money via W-2 employment. Capital gains tax is capped, and is lower than my normal income tax rate. Capital gains aren’t taxed unless the mutual fund declares a capital gains distribution (VTSAX doesn’t do that, nor do most ETFs. However, other index fund providers do declare some small capital gains.). Therefore the fact that capital gains aren’t taxed until I sell helps the accumulation process.

    The favorable treatment of capital gains is also causing me to pause and think about pulling the trigger. Having $200K invested is providing significant capital gains and improving my net worth faster than the savings on a 3% interest rate.

    When selling the investments, don’t forget to also account for the ACA (Affordable Care Act) 3.8% surtax on Net Investment Income (NII). It may or may not apply depending on your situation. (But it probably applies if you have significant capital gains.)

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