This One's on the House

It seems like such a simple question that should have a simple answer.

“Should we pay off our house early or not?”

I get the impression that most of the people who ask me this question don’t expect me to engage them in a 45-minute discussion about all of the different angles they need to consider. But the problem with this question, like so many things in the financial realm, is that people are looking for a simple, definitive answer to something that actually requires a nuanced discussion. So perhaps it would be helpful to deconstruct some of the statements we hear on this topic.

“With interest rates so low, you’re better off investing that money instead of putting it toward the house.”

There’s an element of truth to this in many situations. For instance, if you’re a 35-year-old with a 3.5% interest rate on a 15-year mortgage, then yes…there’s a pretty good chance that you’re better off putting that extra $150/month into the market instead of paying extra principal on the house.

The problem is when people subscribe to this idea, but then don’t actually invest their money in a way that’s going to make it grow.  One example:

I met with a couple a few years ago who owed $25,000 on their house, and their plan was to continue making minimum payments to have it paid off by the time they retired in four years. At an interest rate just above 3%, they had no motivation to pay it off more quickly because they could “make more than 3% by investing that money instead.”

The only problem was that they had $115,000 sitting in a money market account earning less than 1% interest. In their case, there was absolutely no reason not to take $25,000 from that account and pay off the house. They were tickled pink to get my “permission” to do just that; the problem was that they’d heard too many people say that they’d be better off not to. But that math doesn’t work if you’re not actually investing the money in a place that’s going earn you more than what you’re paying in interest.

“We need to keep the mortgage so that we can deduct the interest on our taxes.”

So let’s say this another way. “I’d rather send a dollar to the bank than send a quarter to the government.”

I don’t like sending my quarters to the government any more than you do, but I’ve found that sending dollars to the bank is even less exciting.

Let’s suppose your mortgage payment is $1000/month.  And out of that $1000, you’re paying $400 in interest. That’s $4800/year in interest, which, if you’re in the 25% tax bracket, is equivalent to a $1200 tax deduction.

See how you’d be a lot better off to just have your home paid off and not have paid the $4800 in interest in the first place? Go ahead and send your $1200 to Uncle Sam, and if that extra $3600 in your pocket really bothers you, perhaps you’d be interested in purchasing my oceanfront property in Arizona. From my front porch, you can see the sea. (And if you’re a George Strait fan, you’re welcome for getting that stuck in your head for the rest of the day).

Now, so far it probably seems like paying off the house ASAP is the best way to go.

Not always. Here’s an immediate example that comes to mind where that’s not the best idea.

I have several clients in their late 50s/early 60s who don’t plan to stay in their current home for more than 5-6 more years. Either they’ll be downsizing to a smaller house in the area, moving to a different area altogether once they retire, or moving into a retirement community.

In these cases, it usually doesn’t make sense to pour more money into the house. What if it sits on the market for several months before it sells? Then we’ll be kicking ourselves for having so much equity trapped in the house instead of easily liquid and available for a down payment on the new place.

So if you’re not committed to the house for the foreseeable future, it rarely makes sense to try and pay it off any faster than you have to.

Of course, there are always exceptions to everything, so you really do have to make the decision that’s best for you. Don’t be afraid of the nuanced discussion.