Pay Off The House!
Jon Sully
5 Minutes
My take on "pay the house vs. invest the money"
I’ve chatted with a few friends in the last several days about the premise of paying off their homes (our current #1 goal) and, when it comes to considering growing wealth and/or retirement, the question of “is it better to pay off the house or invest?” is one I feel I have an experienced answer to.
Pay off the house.
You don’t have to be a math-wiz to know that, assuming you have a reasonable interest rate on your mortgage (let’s say < 5%), you will technically end up with more overall money if you invest all of your disposable income instead of paying off the mortgage quicker. That is true. But the key here, to me, isn’t the arbitrage gains math between your mortgage interest rate and the stock market rates — it’s the “if you invest all of your disposable income”. The problem being: you actually have to do it.
I’ve played the game before and the reality (for me, at least) is that purely investing your money is a much harder (and more ethereal) carrot to keep your gaze and hyper-focus on throughout the many years you must keep at it. If you miss a few months or don’t invest all of your disposable income or slip up too much, it will have been better to just invest in the house the whole time. And the thing about treating your mortgage as your primary investment and pouring money into it is that you live there! You’re staring at it all the time. It’s a carrot right in front of you. You can visualize (to some degree) what it looks like to own 30%, 40%, 50%… just count your rooms!
Playing arbitrage and investing in the market instead of paying the house off early because the market could technically get you more money at the end of the day requires that you actually do it. I wager that, for the average person (including myself), it soon feels easier to pull a small amount of money away from “the investment money” every month than if it’s “the house money”.
That’s not to mention at all the ethics and beliefs of debt, the pride of a paid off home, the legacy-component of an owned house in the family, or even the fact that the market (and its returns) aren’t consistent, etc. This is only to speak specifically to the argument that it’s more lucrative to invest the money instead of pay off the home early. It is. But you (and I) won’t do it. Paying off the house, however, we can actually do. If the investing math ahead-of-time yields “$300k more!” by following the investing route but you never fully follow the investing route, you end up with significantly less!
That’s all I have to say about that… but I’ll leave with some example math that’s a touch more realistic.
Example case: $300k mortgage, $0 down, 4.5% interest rate, 30 year. Base payment: $1,500/mo. Say you have an extra $1,000 per month to put towards either the mortgage or investing.
Option A: You put that extra $1,000/mo towards the mortgage from day one, you’ll have the whole thing paid off in 13 years, 2 months — less than half the time expected! You’ll have paid $98k in interest and will have exhibited great discipline and control over those 13 years to work towards your goal. You then spend the next 17 years investing in the stock market at a rate of your prior mortgage base-payment plus that extra $1,000/mo every month ($2,500/mo). Fueled by 13 years of being consistent in your goal-reaching mindset, you’re likely to be more consistent in your investing now too. Assuming a 6.5% return on those 17 years, you’ll end up with a stock value of just about $930,000. So, after 30 years you’ll have a paid off house (well lived-in and not stressed over for the last 17 years) worth likely above $500k (as home values rise) plus $930,000 in the bank. That’s about $1.4 million in net worth. That’s the perfect scenario.
Option B: You put that extra $1,000/mo towards the stock market and average a 6.5% return over the course of 30 years. After 30 years you’ll have finally paid off the mortgage (having spent $250k on interest in total) and your investment balance is $1.1 million. Again assuming your home is now worth above $500k, that means your net worth is $1.6 million. This is also the perfect scenario on this side of the fence — the theoretical math that most financial ‘gurus’ say is the best. It’s true, you do come out ahead here with an additional $200,000 thanks to the power of compounding interest! But is it realistic?
The point of this post is that life isn’t the ‘perfect scenario’. Let’s run these scenarios again with a little ‘life’ mixed in.
Option A + Life: You put that extra $1,000/mo towards the mortgage from day one. You have some hiccups each year as life pops up but you stay focused on the home because you’re in it and looking at it every day. “Pay off the house” becomes your mantra! We’ll equate your average over-pay to $900/mo. In this scenario you pay off the home in 14 years even. Just a little longer than before. You spend the next 16 years investing in the market, again, fueled by your prior discipline but with a little ‘life’ mixed in. Instead of $2,500/mo towards the market, let’s say we average $2,100/mo. At the end of 30 years your investments total at just over $700,000. Adding your house (and ignoring the anxiety-free 16 years with no mortgage!), your net worth is $1.2 million.
Option B + Life: Let’s say you start and stay strong in investing that extra $1,000/mo into the market for the first 2 years. After that, life happens, things change, etc. and realistically your investment comes down to $500/mo (yearly average) for the remaining 28 years. That’ll net you $630,000 in your investment account at the end of 30 years. Add the $500k for the house you by-that-time paid off and you get a total net worth of: $1.1 million.
Once you start mixing ‘life’ into each scenario, the numbers no longer behave like the pure-math they’re touted as being!
Pay off the house!