Why you shouldn’t pay down your mortgage debt

Why you shouldn’t pay down your mortgage debt

You might wonder why Ana advises against paying down your mortgage. Conventional wisdom says you should get rid of your debt, right?

Here’s a bit of contrarian advice that will make you richer over the long run: Don’t pay down your mortgage (any more than is required) until you have built up an investment account that is big enough to pay off your mortgage. Then, update your plan and I'll guide you when to pay it off.

This suggestion goes against the grain of popular financial advice. Your news feed is probably full of articles about the benefits of 15-year mortgages and the feeling of freedom that accompanies owning your home free and clear.

Here’s what that advice misses: Debt against your primary residence offers some of the best – if not the best – loan terms available. A 30-year mortgage lets you lock in today’s rock-bottom rates for decades. The mathematical fact is that if you can't earn (on average) more than the after- tax cost of your mortgage, there are other, more significant problems with your financial plan.

In another disadvantage to owning your home free and clear, paying down the mortgage on your primary residence ties up capital in a relatively illiquid asset. By putting those funds into an investment account instead, you can lower your risk and boost your liquidity.

If you have a mortgage at a 3% interest rate and you get a 6% return on your investments, you’re using your lender’s money to get wealthier. It’s called the intelligent use of strategic debt, and it’s a strategy favored by corporate CFOs.

The children of the Great Depression celebrated paying off their home loans with mortgage-burning parties. Today’s investors are wise to forget about paying down the mortgage. Instead, use the bank’s money to fatten up your
retirement savings.

A Tale of Three Families: The Nadas, The Steadys and The Radicals

Here’s an illustration of how the savvy use of mortgage debt can enhance your retirement security. Take three couples of the same age: Each makes $120,000 a year, each takes a $300,000 mortgage on nearly identical homes, each has $30,000 annually to devote to mortgage payments and retirement savings, and each makes the same 6% return on their retirement savings.

For the purposes of this exercise, we’ll assume each couple takes an interest-only mortgage.

One couple – the Nadas – fears debt. They devote their extra income not to retirement savings but to retiring their mortgage. The good news for them is that, after 12 years of mortgage payments of $2,500 a month, they’re debt-free. Now, at age 47, they start investing the $2,500 that had gone to the mortgage into retirement savings. The Nadas reach retirement age with $1 million. They’ve seemingly taken the most responsible path, but with a return of 6% a year, their $1 million nest egg will yield income of just $60,000 a year, or $5,000 a month.

The next couple – the Steadys – is a bit more comfortable with debt. They opt to pay just $1,250 per month on their mortgage and devote the other $1,250 to retirement savings. They retire with $1.25 million, paying off their mortgage at age 65. They’re a bit better off, thanks to the extra 12 years of compounded returns, but not substantially so. After retirement, their 6% return yields income of $75,000 a year, or $6,250 a month.

The third family – the Radicals – rejects conventional wisdom. Instead of aggressively paying down their mortgage, they pay only the interest on their mortgage, which costs $750 a month. They devote the other monthly $1,750 to retirement savings.

This approach might seem risky, but consider the benefits: At age 65, the Radicals have amassed a retirement nest egg worth $1.75 million. Even after paying off the $300,000 they still owe on their mortgage, the Radicals’ account balance is worth $200,000 more than that of the Steadys and $450,000 more than that of the Nadas.

And the Radicals can keep the $300,000 mortgage – the $1.75 million nest egg will throw off $8,750 in monthly income, enough to pay the $750 a month in mortgage interest while still providing a heftier income than their neighbors have.

In other words, a strategy that might seem reckless far outperformed the more cautious approach.

A couple of caveats about mortgage debt

First, there’s no right or wrong answer when it comes to paying down the mortgage. If your nerves are frazzled by the thought of owing on your house, then pay down the mortgage.

Second, make sure you’re paying as little as possible for your mortgage debt. Rates had fallen below 3% in early 2021, but getting that rate required a strong credit score. Also, you’ll probably need to limit your mortgage debt to 80% of your home’s value. Borrow more than that, and you’ll have to pay for private mortgage insurance, which boosts your borrowing costs.


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