A lot of people subscribe to the Dave Ramsey school of thought: pay off all debts, including your mortgage, and you will be financially smart and safe. While I can see why many people think it is smart to pay off a mortgage, I have a different viewpoint. I think it is actually unwise to try to pay off your mortgage in many situations. I do not think it is a good investment or a safe investment for most situations. I do not say this to be a contrarian but from personal experience and the many stories I have heard from others. When you pay off your mortgage or pay extra towards your mortgage, you are earning a very small return on your money. Mortgages have extremely low rates and are some of the best loans available for consumers. Many people also spend all of their extra money paying extra towards their mortgage when that money could be used as an emergency fund or to invest in other assets. Finally, a house is a very hard asset to get money out of. You cannot easily sell or refinance a house if you end up needing that money.
How and when did I pay off one of my mortgages?
I am not saying you should never pay a house off: it does have some advantages. In fact, I paid a house off a few years ago. It was my first rental property, and I used all my extra cash flow from my rentals to pay off that house. I paid it off three years after I bought it, and I was really proud of myself. Everyone always said the smart thing to do was to pay off houses, and I had done it! But was it a good decision?
When I first bought the house, my loan was about $73,000. Over the next three years, I spent about $65,000 paying off that house over and above my mortgage payments. That $65,000 saved me about $400 per month. However, I did not see that savings until the house was completely paid off. For three years, I saw almost no return on my money. I started to wonder if this was a good idea since I was making more than 15% cash-on-cash return on the rentals I bought. By using that $65,000 to pay off the loan, I had sacrificed being able to buy more properties, which would have made me much more money. I also like to get good deals on my rentals. They have awesome tax advantages, and they may appreciate. None of these additional advantages are calculated into my 15% cash-on-cash return. I decided that while it was cool I had paid off the loan, it was not the smartest thing I could have done. I ended up getting a line of credit against the property and used that to buy more rentals and flip more houses.
Below you can watch a video on how well my first rental has performed over the years.
What about paying off a mortgage if you’re not a real estate investor?
I am in a unique situation where I can make a lot of money in real estate. Actually, many people can make a lot of money in real estate, but few do it. What about people who buy a house, have a regular job, and want to retire at 65? Is it smart for them to pay off their mortgage? I was in this same situation earlier in my career, and I think I made another mistake paying off my mortgage early (or trying to).
As a young real estate agent, I did not make a ton of money. I did not have any rentals yet, but I had a personal house that I had bought when I was 23. I bought the house for $190,000 and thought that making extra mortgage payments and or sending in extra money to pay off the house was smart. Whenever I had a good month, I would send in extra money with the normal mortgage payment. I started to see my principal balance slowly go down a little more than it had in the past. However, real estate is an up-and-down business. Some months, I did not make as much money, and I had no extra money to pay off the mortgage or even to live on. I used my credit cards to make up the difference. I would slowly pay off those cards, but the cards had an extremely high interest rate. I was actually losing money because the rate was so much higher on my credit cards than it was on my house payment. I would have been so much better off saving that money for a rainy day than paying off the mortgage.
An emergency fund is something that everyone should have. An emergency fund usually consists of 6 months of living expenses. If you get sick, are in an accident, or lose your job, you will have money to live on. If you are one of the 39% of Americans who do not have enough money to cover a $1,000 emergency, do not pay any more to your mortgage than you have to! Even if you have $10,000 saved up, or $100,000, it may not be wise to pay more towards your mortgage than you have to. If you ever need that money, it will be very hard to access it.
Why is it hard to pull money out of a house?
Real estate can be an amazing investment, whether you are buying a house to live in or a rental property. One drawback to real estate is that it is hard to pull money out of a house. I could buy a house for $200,000, pay down the mortgage to $100,000, and have the house appreciate to $300,000 in a few years. On paper, I would have $200,000 of equity in the house, but you cannot simply go to the bank and withdraw that equity. To get the money out of the house, you would have to get a loan or sell the house. Even if I had no mortgage on the house, I would have to sell or get a new loan to take any money out of it. This is why paying off your mortgage is not the safest investment to make. If I need money, I may have to wait months to access it or sell at a huge discount to get to the money fast.
I have talked to many people who thought they were doing the smart thing by paying off their house. A lot of them were very well off financially and had semi-retired or completely retired. They decided to take some money out of their paid-off house to invest in real estate. They were surprised that the banks would not give them a loan because they had no income or very little income. It does not matter if you have $300,000 in equity in a house and no other debts. without income, it will be almost impossible to get a loan on a house.
Many people who get into financial trouble and need money from their house are not able to access it. If you have medical bills that hurt your credit, lose your job, or get sick and cannot work, it could be hard to get a loan when you need it most. That leaves people with one option: to sell their house to get the money out. When you sell your house, it can take months, you have a lot of costs involved, and you have to find a new place to live. If you are in a bad financial position or retired, it could be very hard to buy a new house. You are now forced to rent.
How much are you saving by paying off your mortgage?
Something else to consider is how much money you are actually saving by paying off your mortgage? Have you run the numbers to make sure it is a wise decision, or are you simply doing it because other people have told you it is the smart thing to do? Here are some numbers on a 30-year mortgage for $300,000 at 4% interest;
- Payment: $1,432.25
- Total principal paid: $300,000.00
- Total interest paid: $215,608.52
If you look at the numbers above, you would save over $1,400 per month by paying off your mortgage (you may save even more if you have mortgage insurance on the loan). People think they will be financially safe without that $1,400 per month payment, but is it really that big of an advantage? Eliminating that payment saves about $17,184 per year, which is not a lot of money in today’s world. It will take a while to pay off that $300,000 mortgage, and until you pay off the entire mortgage, you are not saving any money (unless you can recast the loan). If you have an emergency or a need for money comes along before that mortgage is paid off, it has done you no good to pay off the loan early. You still have the mortgage payment to make.
A lot of lenders will convince you that a 30-year mortgage is not a good investment because you pay so much money interest. Yes, you pay a lot of money in interest, but you pay that money over 30 years. Lenders try to scare people into refinancing their mortgages into 15-year mortgages because lenders make money every time you refinance. I have written a different article that goes over a 15- versus a 30-year loan here.
What happens if you can’t make your mortgage payments?
Something else to consider is what happens when you stop making your mortgage payments. Many people assume when you can’t make your payments, you lose the house to foreclosure and get kicked out. The process when you stop making payments on a mortgage varies in every state, but you cannot simply be kicked out as soon as you stop making payments. Here is how the process usually works:
- Once a homeowner gets behind on payments, the bank must start the foreclosure process. This usually occurs after about three missed payments.
- The homeowner and all lien holders are notified of the foreclosure.
- The courts or trustee must approve the foreclosure.
- The actual foreclosure process can take from a couple of months to 3 years in some states.
- The house goes to the foreclosure sale, and the bank or a third party can buy the house.
The foreclosure process can take anywhere from 3 months (very rare) to over 3 years after the homeowner stops making house payments. The homeowner still has possession of the house that entire time. They do not have to move out. The bank will continue to pay the taxes and insurance to protect their investment. Even once the house sells at the foreclosure sale, the homeowner still has possession. The bank or third party will have to go through an eviction to get the homeowners out of the house. The banks will often pay the occupants cash for keys to move out of the house. The cash for keys amount could range from $500 to $10,000 depending on the bank and the house.
Most people who stop making mortgage payments are able to live rent free and mortgage free in their house for at least a year and are then paid to move out. If you end up in a bad situation where you cannot make your house payments, it is not nearly as bad as many people think.
What is my advice on paying off a mortgage?
Paying off a mortgage could be a smart move for some people, but I think most people are better off not paying extra towards their house payment.
- Interest rates are extremely low, and you are not saving very much money compared to how extra money you have to spend paying off the loan. If you have a way to invest your money and make more than a 5% return on it, I think you should invest the money in something that will start making you money right away. That investment will most likely be more liquid and easier to access as well.
- If you are paying extra towards your mortgage, make sure you have an emergency fund saved up first. It is too hard to access money in your house if that is the only savings you have.
- Do not rely on the savings in your house as a retirement fund. You will still have costs to live in that house even without a mortgage like property taxes, insurance, utilities, maintenance, and you will have living expenses as well.
- Think about if the savings you are getting from paying down the mortgage is worth all the money you will spend paying it down.
I personally do not spend any money paying extra on any of my mortgages. I can make much more money in real estate than the low-interest rates I get on my mortgages. I also think it is much safer to have cash in my accounts or in easily accessible investments than in my houses. I still have a lot of equity in my houses because I get great deals on them and put 20% or more down on them, but I don’t pay any more than I have to on the mortgage payment.
For more information on how to make buying a house a great investment, check out my book: How to Buy a House: What Everyone Should Know Before They Buy or Sell a Home.