Why you (probably) shouldn’t pay off your mortgage early

Obligatory disclaimer: I’m not a CFP, fiduciary, CPA, or lawyer. I cannot be held liable for any investment or financial management decisions you make based on my blog rambling.

For me, a mortgage comes with a heavy emotional weight. When I was young, my family went through bankruptcy and we were afraid that we’d lose our house. I remember my mom talking about it a lot, and I was pretty scared of what bankruptcy was going to lead to for us. We were going to be living in our car? But no, my mom was worried we’d lose the car too. What then?!

That’s neither here nor there. Suffice it to say, when we bought our first house, I wanted to pay it off ASAP. The best we could do then was an extra $100/month, which on a 30-year mortgage typically reduces your payoff schedule by 11 years! So we’d pay it off in 19 years instead of 30.

When we sold that house 6 years later and bought our new one, I was… what, 29? Almost 30. And I was looking at our 30-year mortgage and thinking we could pay it off by the time I was 40. Score!

But I was also starting to learn more about personal finance around that time. And over the next 2-3 years, I would start budgeting better and investing more to build our retirement savings. It became increasingly clear to me that paying off our 3.875% mortgage didn’t make much sense when I could put that same money into the stock market for an inflation-adjusted return of 7% compounded over the next 20 years. (And if we just look at the last few years, I’ve been getting more like 15% per annum.)

Then coronavirus came and interest rates fell through the floor. In 2020, we refinanced our house and took cash out of our equity for home improvement projects. We switched from a 30-year mortgage to a 15-year, our monthly payment went up by ~$400, our interest rate dropped to 2.875%, and our total savings on interest will be over $25,000 compared to the 30-year, even with the increased debt from the cash-out refi. We’ll also pay off our mortgage several years sooner than we’d originally anticipated.

I just checked and we could throw everything “extra” at the mortgage and pay it off in 4.5 years. By extra, I mean reducing retirement investments and not going on vacation ever and maintaining a gazelle-like focus on paying off the mortgage. For the sake of clarity, our mortgage balance is currently $142,998.96.

Given the short time-frame, you should use 10% in a compound interest calculator to compare against investing in indexes. 4-5 years is a bit short for averaging index returns, but this is all hypothetical, so let’s not worry about it. Investing everything that we might throw at the mortgage in 5 years only returns $139,196. That’s $3,802 less than paying off the mortgage. So it makes more sense to pay off the mortgage, right? Nope.

Two reasons:

  1. The money put into the mortgage is illiquid. If we have an emergency or need cash for some reason, I can pull contributions from the Roth IRA with no penalty, or even take a loan from our 401k. With the money tied up in the mortgage, I might be able to get a HELOC or another cash-out refinance, but there’s no guarantee of that.
  2. While my end-balance when investing might be at, or even below, $139k, that money will continue being compounded past year 5. If I pay off the mortgage, then my cash flow has increased beginning in year 5 or 6, which means I can put more money into investing… but I’ve lost 5 years of tax-advantaged 401k and IRA contributions, and then 15+ more years of those contributions compounding. That’s a HUGE impact long-term.

You can’t just compare mortgage pay-off vs. investment return during the same time frame. Instead, you have to look at the long-term impact.

And for us, we can split the difference. We refinanced to a 15-year loan, so we’ll pay it off faster than our original 19-year plan. And we lowered our interest rate.

We can’t invest as much as we would if our mortgage was paid off right now, but by investing during these next 5 years while paying on the mortgage, and over the total 15-year period… This is very back-of-the-napkin made-up math at this point, but I’d put the end result of “slowly” paying off the mortgage over 15 years while investing for our retirement at:

  • Mortgage is paid off
  • $663,406 in investment accounts

Alternatively, we could pay off the mortgage in 5 years, then start investing. After 15 years, we’d be at:

  • Mortgage is paid off
  • $477,496 in investment accounts

Those 5 years of investing while paying off the mortgage more slowly (over 15 years total) make a significant difference in our investment balance.

You can see this comparison easily yourself by going to https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator and put in the amount you can invest for retirement right now for the duration of your mortgage (15, 30, 20, whatever). 7% is a good estimated rate of return over longer timeframes because indexes tend to average 10%, less 3% average inflation rate. The number you’ll get is present value, not future value.

Then, run it again but add your mortgage payment (just the mortgage, not taxes + insurance) to the monthly contribution amount and change the length of time. For me, my first calculation is 15 years, and the second is 10.

So, generally speaking, no, you shouldn’t prioritize paying off your mortgage. I would add, though, that is only true if your interest rate is below ~5%. And if it’s not, you should see if you can refinance and lower your rate. We used RocketMortgage and it was a great experience.

It has taken me a couple of years to set aside my emotions on this. It was really hard for me. But a lot of fiddling with undebt.it and YNAB and spreadsheets and my mortgage lender’s amortization calculators helped me see that paying off the mortgage early is purely an emotional decision and not a good financial one. There’s almost no situation in which paying off the mortgage early makes sense for us. I’d wager that it doesn’t make good financial sense for most people.

If we somehow hit our first FIRE (Financial Independence Retire Early) goal (3.25% SWR with $50,000/year) before our mortgage is paid off, then I may reduce investments and pay off the mortgage a bit sooner just to lock FI status in, since I can’t RE with a mortgage payment. Even then, I would recognize that paying off the mortgage is more of an emotional than a financial decision.

And that’s OK. The most important thing is that you’re able to sleep at night. I can now, but I used to really stress about this stuff. If your mortgage keeps you up, then pay it off sooner. But know that long-term it’s going to cost you a lot.