In the last 12-18 months, I’ve fielded a lot of questions about mortgages and how they tie into your financial plan.  There seems to be a knee jerk reaction that not carrying a mortgage is your best option and that the sooner you can relieve yourself from all debt – the better.  Sometimes this is accurate, sometimes it’s not.

Scenarios do exist where paying off your mortgage or paying your mortgage down more aggressively does benefit you financially and emotionally.  I’ve determined that those are mostly the anomaly.  I’ve also determined that not carrying a mortgage could be one of the riskier decisions you make.  For most people, carrying a mortgage allows for greater wealth creation and far greater flexibility.

  • Let’s start with the obvious one.  With historically low interest rates, the numbers are in your favor.  Long term wealth accumulation favors the equity markets vs tying your money up in your house.  Your home’s value will go up or down regardless of whether you carry a mortgage.  They are independent of each other.  The money you save in interest, nearly always pails in comparison to a long-term equity investment strategy.  An illustration on this below.  Also, a caveat: this would be a drastically different conversation in the 1980s.
  • Flexibility may be an even more important reason.  If you buy a house with cash or pay your mortgage off aggressively, your only way to access that money is to either refinance your home or sell it.  Why put yourself in this position?  Do any of us know what sort of needs we’ll have in the next 15-30 years (mortgage timeframes)?  In an equity market, nearly all your securities are available to you within days of trades being processed.  Nor do you have to liquidate an entire account.  Imagine being settled in your home with children, a large medical situation arises for your family, and you need money.  I suspect you’d rather sell stocks than your home.
  • Then, there’s the pride factor.  I’ve heard Dave Ramsey say in his 6th Step to Financial Freedom that the grass will feel different under your feet once your mortgage is retired.  And, often, people will take more pragmatic risks because they no longer have the fear of a mortgage payment hanging over their head.  This is fair.  However, what if you can get there more quickly by simply saving more aggressively?  What if you could replace your income with dividends/interest through your investment accounts because of the nest egg you’ve created?  Doesn’t that provide you the same ability to take a risk?  Or, if you’re retired, doesn’t this provide you even more liquidity?  Your fear of outliving your money is likely gone.  An illustration on this below as well.  Meanwhile, you’ll maintain all flexibility, rather than all assets being tied up in retirement accounts and your home.
  • What I won’t illustrate below (as I won’t do it justice and be able to show all nuances) is the impact of deducting your mortgage interest (assuming you itemize).  This concept alone greatly reduces the actual “interest savings” that you’re most likely calculating if considering mortgage prepayments or cash purchases.

To be clear, I’m drawing a binary either/or conclusion here.  Doing both could be great as well.  This post is about how to prioritize savings vs not carrying a mortgage.  Against conventional wisdom, I’ll contend that paying cash or prepaying your mortgage is one of the riskier things you can do for the sake of your wealth accumulation, preservation, and gaining flexibility.  Please don’t buy this notion that simply being debt free will suddenly change your sense of financial freedom.

Here are 2 examples of maintaining a long mortgage:

Retired Couple in Mid-60s (example 1) and High Income Earning Younger Couple (example 2)

  1. Demographics:
    1. Retired couple in their mid-60s
    1. 2-3mm investable
    1. Home is paid-off or nearly paid-off
    1. Children and grandchildren no longer live close-by
    1.  The house in which they’ve raised their family is no longer necessary and is too much work to maintain.
    1. They decide to downsize

Conventional Wisdom:

  • Sell house
  • Use sale proceeds to pay cash for smaller home
  • Peace of mind from owing someone money

While this certainly won’t hurt you, what about an alternative solution?

  • Sell house
  • Use sale proceeds for a 20% down payment
  • Invest remainder in a conservative portfolio designed to yield interest and dividends
  • Make mortgage payments from portfolio income
    • Example:
      • Sell home for net 1m after commissions/gains paid
      • Buy home for $650,000
      • 20% down payment ($130,000)
      • Invest $870,000 yielding approx. 4% à $34,800/annual yield
      • Obtain $520,000 mortgage, 30 yrs, 3.92% à approx. $30,000/annual payments
      • Increase your liquid/investable net worth between 25-40%
      • Remarkably ease the fear of ever running out of money or needing to adjust your lifestyle
  • Demographics:
    • Married couple, age range 30-45
    • Household income of $500,000 + (this number is very regional when determining its applicability)
    • Make maximum contributions to retirement accounts
    • Properly insured
    • On pace to fund children’s education
    • Homeowners
    • Excess cash flow accumulating in savings/money market account

Conventional Wisdom:

  • Continue above savings strategies and start making additional mortgage payments
  • Pay off 30-year mortgage, in say, 15 years
  • Peace of mind from not owing someone money
  • You’re in position to take more risks without concern of a mortgage payment

While this certainly won’t hurt you, what about an alternative solution?

  • Invest your free cash flow in a portfolio of mostly equities
  • Assume this is a long-term strategy – say, 10 years or more.
  • Assume an annualized 7% growth rate
  • Your mortgage doesn’t affect the value of your home.
  • Consider your mortgage interest is a tax deduction if you itemize
  • Consider that your perspective on life might change inside of your 30-year mortgage.  The typical single family home buyer is expected to remain there for 13 years.  Closer to 11 years for first-time home buyers and 15 years for those who have previously owned.

In both camps (those advocating for and against mortgages), will plea that this is about much more than the numbers.  This isn’t necessarily just about wealth accumulation and preservation – though on a spreadsheet, most cases will undoubtedly lead you towards systematic investing in the stock market compared to prepaying your mortgage.  Time will likely alter this discussion as decades pass and the numbers change.  Most importantly, try your best to look past what is conventional and truly land on what provides you the most wealth and flexibility.

Stay calm. Stay invested.

Thanks for reading,

See disclaimers.

Mitch

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