There are a lot of differing opinions in the finance community on paying off a mortgage early vs. investing the money elsewhere for a better return. My husband and I have already come to the conclusion that we want to get rid of our mortgage as soon as possible. The real question is how we are going to pay our mortgage off early.If we do nothing else and pay our mortgage as scheduled with no extra payments, it will pay off when we are 61 (yikes). This is way past our financial independence and retirement age goals.
Ideally, we would love to pay the mortgage off by 2023 (7 years from now) since that is when I would like to retire from my corporate job. But how do we go about paying off a roughly a $350,000 mortgage 22 years before the original maturity date? Is chucking so much money at the mortgage the best thing to do right now? What if we have a major emergency or lose our jobs in the meantime and need the cash? Can the money used to pay down the mortgage be better invested elsewhere?
Here was the original plan I came up with that would get us close to paying off by 2023:
We would start paying an additional $800 a month towards principal on the mortgage, ($500 from cash flow from our investment property and $300 from a raise I recently got). The $800 in extra payment doesn’t require any cuts to our current budget since it was never accounted for in our spending anyway. By just making these extra payments, the mortgage would pay off when we are 48. That’s not bad, since it shaves 13 years off the original maturity date but it’s not good enough if we want to have no mortgage by 40. So I went a little further.
If we were able to throw extra money at the mortgage from my annual bonus and my husband’s extra jobs, we could speed up the principal pay down even more. Looking at our budget, I think we can manage to squeeze an additional $15,000 a year to put towards the principal payment while still being able to work towards other goals. If we did that for 7 years (8 if you include this year), that would be an additional $120,000 of principal pay-down.
By doing the above, (paying an additional $800 a month and $15,000 a year), the principal balance will be about $122,000 in 2023. So technically, it won’t be paid off but at least we would’ve made huge headways in reducing the principal.
After thinking it through some more, I’ve come up with another plan. What would happen if instead of paying $15,000 directly towards the mortgage principal every year we invested that $15,000 in an index fund every year. Assuming a 6% annual return, that $120,000 investment would grow to $150,000 including paying the capital gains tax. At the end of 7 years, our mortgage balance will be $226,000 (with the $800 a month additional payments). If we take that $150,000 and apply it all to the mortgage, the balance would only be $77,000 in 2023.
Let’s compare the scenarios again:
Scenario 1
-Pay $800 a month
-Pay an additional $15,000 a year towards mortgage principal
-Ending balance will be about $122,000 in 2023
Scenario 2
-Pay $800 a month
-Invest $15,000 a year into index fund assuming a 6% return. Grows to $157,000, Cash out of investments and pay 15% capital gains tax, and we will have $150K to pay down the mortgage
-Ending balance will be about $78,000 in 2023
It seems obvious to me that we should go with Scenario 2. The downsides or risks are that:
- The market could tank and we lose our money which means I need to choose the investment vehicle wisely. I am looking at putting the money in the Vanguard VSTAX mutual fund, which has had a 10.99% historical 5 year annual return or a 7.04% historical 10 year return. If in 2023, the market tanks when are ready to cash out, we would just have to keep our money in for however long it took for the market to bounce back. Since we are also still paying the additional $800 a month towards principal, the mortgage will pay off by the time we are 48 if we are able to pay nothing else towards the principal.
- The fund we choose doesn’t return 6%, it returns less. Technically, as long the investment returns more than our current mortgage rate of 4.375%, we will be in no worse of a position than if we would have if we just paid the mortgage down directly.
Overall, I like the flexibility of having the cash in an investment vehicle that can be easily accessed. Also, what if our plans change over the next 7 years and we want to use the money for something else? Instead of having the equity tied up in the mortgage we can choose to do what we want with it.
So that’s where we are now folks, looking at pursuing Scenario 2.
Have any of you paid off or implemented a mortgage pay off strategy? What are your thoughts on my different scenarios?
P.S. – I always struggle with putting actual numbers into my post. Part of me feels self-conscious when it comes to talking about it but I also know that by being more forthcoming, it can help to connect to much more people. Whether you have higher/lower debts, income or savings than me, you can achieve whatever financial goal you commit and work towards by making it a priority and staying consistent.
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13 Responses
I like that you have documented it in this way! This is one of the things my husband and I aren’t on the same page with. I want to be debt free, including a mortgage, as soon as possible. He’d rather maintain the mortgage and save so we can pay for things we want (like home renovations) in cash. We’re compromising a bit bit once our other debts are paid off I suspect this issue will come to a head.
Thank you! Yes I figure if I put it out publicly it makes me more accountable. And I get having to compromise with your partner. It’s a constant give and take in our household too. I would rather throw every extra $1 to our budget to investing and saving where he would like to enjoy more things in the moment and not feel restricted.
Good to read this article. I like the alternative that you mention. We are going through a similar debate right now. The feedback from the people on the post also point out that it might be better for us to not pay of extra lump sums right now.
The idea of investing that money makes sense to me. Only, at the current valuation, I would hesitate. That is where I like your thinking on downside risk nr 2: make sure to get a return above the cost of the mortgage…
thx for the extra ideas.
Thx for the feedback, it’s certainly something we have gone back and forth about but I’m thinking this strategy may be the best one so far.
We start to lean to that as well…
Your layout plan is great. It good that you are going through all of your possible options. Personally for myself, I think its important to be liquid (meaning money in the bank or in investments), outside of paying off debt so I would go for scenario #2, that way if you guys change your minds for whatever reason or you run into financial hardship, you won’t need to pull the equity from your home just get buy (assuming you also run out of your emergency fund). its good that you are planning ahead though.
Thx! Yes we are leaning towards scenario 2 for those reasons
Good to see the numbers so you can take the emotion out of the decision. You are lucky to have such low capital gains tax, I’m jealous!
Thanks! yes it’s 15%. What is it in Australia?
It is your marginal tax rate @ 50% but the income is taxed at your marginal tax rate. And we have a more progressive tax system than the US.
I really love this article. It goes a little against the Dave Ramsey doctrine of never using debt however suggesting to get a mortgage. Then, when you do get that mortgage pay it off as soon as possible. That sounds good however you lose all your liquidity paying off your mortgage early where you could be using the extra funds to invest else where as long as you can get a return higher than your current mortgage interest rate.
Yes, I actually need to an update to this article because our goals have since changed a bit. We are choosing to save up more in cash and liquid accounts so that we can prepare for some big changes ahead. But yes, you’re right, logically, if you can make more in another investment vehicle, it makes sense to invest your money there instead of paying off the mortgage. There is nothing like a paid off mortgage so I totally get the emotional reason to want to pay it down faster. Thanks for commenting Tim!