Striving for a Mortgage-Free Life
December 3, 2008 by Mr. GoTo
Filed under Mortgages, Debt, and Credit
If you read much in the area of personal finance you will frequently come across heated debates about the merits of living in a paid-for house as compared to having a mortgage. Some folks will argue that mortgage money is cheap and that taking into account the tax benefits, it makes more sense to keep the mortgage and use the extra cash to invest. I get that. Other folks point to the emotional benefits of being debt-free and actually owning your home free and clear of any mortgage obligations. I get that too.
Reconsidering Mortgage Payoff Issues
Guaranteed Rate of Return on Investment
Our mortage interest rates are in the 6% range. Every extra dollar we pay toward the mortgage balance gives us a guaranteed rate of return of 6%, tax free. Compare that to what we have experienced in the markets recently. Moreover, I have no confidence that market returns will be anything but flat for the foreseeable future. So I’m going with a sure thing.
Tax Free Shelter Services
Our house is our home but in the economic world it is more than that. It is a source of what economists call “shelter services.” Shelter services are a necessity, not an option. You can get them from a house you own, a rental apartment, friends or family, or even a homeless shelter. If you rent or have a mortgage, you need to pay for those services. You need income to make those payments. Generally you will pay income taxes on that income.
Now if you own your home with no mortgage payment, you still receive the shelter services. But now those services are “free” in the sense that you do not need any cash flow to pay for them. (I am excluding from this analysis property taxes, insurance and maintenance costs, which are typically much lower than mortgage payments.) Since I don’t need income to pay for our shelter services, I won’t be paying any tax for receiving those services. That will really come in handy when we are retired and trying to keep our investment withdrawal income down so that we can maximize our Social Security benefits. I expect marginal tax rates to increase. I also expect that Social Security benefits will eventually be “means tested”, i.e., the benefit levels may be adjusted depending on your other income. If I don’t need as much “other income” because I have no mortgage payment to make, I can reduce the impact of means testing on our Social Security retirement benefits.
Reduced Financial Risk
As we get older, the odds of a health-related problem increase. At the same time, my earning capacity will decrease. I want to minimize the risk that a money catastrophe will force us into doing something drastic or cause us to lose our home because we can’t make the payments. Also, we want to be in a position where we can ride out an extended downturn in the market and not have to sell investments to meet everyday living expenses. Having a paid-off mortgage reduces both of those risks.
Peace of Mind
There is a certain level of peace, contentment and satisfaction that I expect will come when we have paid off our mortgages. I have often heard others talk about it. This is an intangible benefit but it may be one of the most important. If you think about it, part of the peace of mind factor is tangible. If as Mrs. GoTo and I get older we need additional income due to financial emergency, we can look into a reverse mortgage. That is always easier to do if your home is paid-for.
Countering the Counter-Arguments
I’ve already addressed the biggest argument against paying off your mortgage, i.e., using the free cash to invest. As I said, we have opted for the guaranteed 6% tax free return that we get from paying it off.
The mortgage proponents also argue the tax benefits from deductibility of the mortgage interest. That benefit is usually overstated. Their analysis of the tax benefit does not consider that only the portion of the annual mortgage interest paid that exceeds the standard deduction is really providing a benefit. This makes it a much smaller benefit than most people think. As one example, a married couple filing a joint tax return in 2008 is entitled to a $10,900 standard deduction. If that couple pays $11,000 in mortgage interest and has another $1500 in deductions, the couple can deduct $12,500 instead of taking the standard deduction. But if you think about it, they are receiving an actual tax benefit only on $1600, which is the difference between the total of that couple’s deductions ($12,500) and their standard deduction ($10,900). If that married couple has an effective tax rate of 30%, the mortgage interest is providing an actual tax benefit of only $480. The couple is paying $11,000 in interest to save $480 in taxes. That is not enough for me to keep a mortgage payment hanging around my neck.
Hopefully I will be able to soon announce that we have begun our mortgage-free life.
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I had made the decision to pay off our remaining mortgage balance when I retired earlier this year. However, at the time I retired, we were able to put that money into a CD that paid over 5% while our adjustable rate mortgage was at 4.75%. So we decided instead to keep the cash and revisit the decision once the mortgage adjusts in November of 2009.
As it stands right now, since treasury rates are so low, if our mortgage were to adjust today, it would be 3.75%! So, we’ll just wait and see how the comparison looks between guaranteed money (CD’s) and guaranteed savings (mortgage rate, if we paid it off). I have a sneaking suspicion the rate will be even lower than that late next year, but we’ll just have to wait and see . . .
Syd: Your strategy may work but taking into account taxes, what are you yielding on that CD? It may actually be lower than the 4.75% on your mortgage.
You are right, the 5.25% CD isn’t really 5.25% after tax, but neither is the 4.75% mortgage 4.75% cost. The CD interest is taxable, but the mortgage interest is deductible, so both numbers net to a bit lower, but their relationship stays the same (i.e. the net amount of interest I’m paying always stays lower than the net amount I’m earning.)
Syd: The tax adjusted net yield on the mortgage may or may not change depending on the interest and other itemized deductions compared to the standard deduction. In other words, you are only getting a tax benefit to the extent that your mortgage interest exceeds your standard deduction.
Fortunately, we are seeing a lot less of the pro-mortgage, borrow until your house bleeds types of people shouting as loudly as they did a couple of years ago.
The current financial fiasco is a great reason to be on the debt free side.
It’s all about eliminating risk for me and I aspire to have my house paid off in the next 10 – 15 years (slowed by other debts that I’m still working on).
I’m planning on paying off my house by the time I’m 40. I want to get rid of my mortgage as early as possible since that will then give me more freedom to do what I like.
I know there are many debates as to what the best thing is money-wise but a lot of the time, I think you just have to do what feels right for you. There’s nothing better than feeling good about something, it can make the world of difference.
Andy – a paid off home at 40 – that would be impressive. Congrats. I am happy that I will be able to pay ours off before age 60!
@Andy: We had paid down over half of our mortgage before I retired. And you are right, it felt VERY good to be doing that. In hindsight though, I kind of wish I held on to a little of that cash for a rainy day, or, say a 52% decline in the stock market, as the case may be.
But who knows, if I still had the cash, perhaps I would have invested it in the market and then where would I be?
We paid our mortgage off Dec. ‘06! One can make ALL the arguments about taking your ‘excess’ payments and investing it for a better return (I know I did the same), however, how well do you sleep at night thinking about ‘your’ money? Given the market we are in today, the ‘peace of mind’ we enjoy has a much greater rate of return and quality of life than any ‘investment’ could provide. I would recommend that you try being on this side of the fence (pay off your mortgage)- then see whether you feel the same! You can always go get another ‘mortgage’ if you disagee – the meaning of mort (death) gage (grip) vs. NO mortage (peace of mind) – you decide, I did!
Paul – That is an awesome accomplishment. Care to share any of the strageties you used to complete the payoff?
Financial columnist Scott Burns has always advocated a paid-off mortgage as a superior financial instrument in that it provides “imputed income” in the form of sheleter services.
Here’s a link to a 2002 column he did about this which inspired me to pay my house off in 2005:
http://www.dallasnews.com/s/dws/bus/scottburns/columns/2002/stories/burns_08bus.ART0.90109.html
And here’s a website which provides a deluge of reasons to pay off your mortgage….long but worth the read!
http://homefinancefreedom.blogspot.com/2007/10/homeownership-cost-cliches-housing.html
I am 44 years old. If I continue to live below my means, I should have my house paid off when I am 49. I am a firm believer that FREEDOM IS BEING DEBT FREE, and there is no freedom in owing tens or hundreds of thousands to a financial institution. Look at what has happened to 401(K) accounts and to the stock market. I will not even bother doing the math to compare a return percentage here and there. I have calculated that I can live on little after my biggest expense, which is m mortgage, is gone.
Freedom is being debt free? Tell that to Donald Trump or Warren Buffett. They sure missed those lessons. You can borrow money backed by the asset of your home at less than 5% today. CD rates are at HISTORIC LOWS as well. 5-10 years from now, what will it cost to take money out of your house and make it liquid? If rates return to the late 70s, early 80s levels, you could have 13% return on a CD while owning a fixed house loan with a 4.75% interst rate. Please tell me why on earth you would want to pay off your mortgage when rates are cheap. Now is the time to borrow and stick in guaranteed liquid assets. CASH IS KING in a rough economy. Paying off your mortgage isn’t CASH it’s investment. Bad investment (obviously if you haven’t learned that yet, you’ve missed the news lately). Stay liquid, and when rates inevitably return, even in safe investments, you will reap enormous rewards. Besides, how does it hurt to earn 5% in a CD instead of paying a 5% mortgage rate? Actually, with the tax benefits, the CD makes a little better sense now, and absolute sense in the long-term.
Oilengineer: Meet Carlos.
Oil Engineer – I can make 6% tax free paying off the mortgage with zero investment risk. At age 58 that is a great deal for me. Tell me where else I can get a 6% tax free return anywhere right now or in the foreseeable future? Then tell me how much risk there is with that investment.
Donald Trump is a PR clown who has made just as many investment losers as winners. I don’t want to learn my over-leveraging lessons in bankruptcy court like Trump has.
I don’t know why everyone keeps saying to “be like Warren Buffet.” The man is a billionaire who made most of his money in prior decades. Now he can take risks that you or I can’t even dream about.
When you find that 13% CD I will know, because inflation will be eating us up. That’s when I want low taxes which I can get by living in a paid-for home that is providing me shelter for free.
Thanks for visiting and the comment.
Paying off the mortgage to get nearly rent-free living quarters is certainly a worthy goal. But I think it’s worth remembering it’s not a risk-free investment. The value of housing has dramatically declined. Stocks, bonds, real estate, commodities, even cash–NOTHING is a risk-free investment.
And I have to agree with Oil Engineer in one respect, if you need cash, it’s a lot harder to get it out of your house these days than it would have been if it were sitting in your bank account. The decision doesn’t just boil down to the rate you can earn (or save) by paying it off, but also your liquidity needs. An important factor for someone like me who is newly retired and needs to keep an eye on where the cash will be coming from.
At 50, I paid cash for a small home, and paid cash for remodeling it to 1010 sq ft. This is my retirement-forever home… so for the next 50 years or so (until I die or go into a nursing home) I will be living mortgage free in this home. 50 years of no mortgage is a long long time. The insurance and taxes are under $100/month, and as everything was new with the remodeling, most everything, save minor repairs and paint, should last til I die.
My house has not decreased in value as I bought a fixer-upper at the price of the land, and did a lot of the labor for remodeling myself. The value of the house after construction is way more than I have in it – I am happy!
50 years +/- of no mortgage…. think about that! I sleep well at night! Peace of mind cannot be bought…. but a mortgage free life sure contributes to it!
Marci – Congratulations on your situation. i’m sure there are many others who would appreciate having what you have achieved for yourself.
I paid off my mortgage for my 53rd birthday. I’m still working full time and plan to retire next year. The amount of money that piles up is astounding when I’m not paying a mortgage so I am quickly building cash reserves from all that money that isn’t paying a bank. It feels great being debt free at 53. Tho I don’t pay “rent”, it isn’t free – I still have to pay property tax and insurance on it.
I did it by paying more on the mortgage than I owe each month. In 2003 when rates were low, I refinanced with a very low rate on a 7 year balloon amortized at 30 years. Then I paid 4x the mortgage each month and paid it off in <5 years. I look at it as a total cost problem – how much does it cost me vs. what it is worth. Because I paid so much less in interest, it is still worth more than I have put into it after the big real estate fall. And I have a place to live in in the meantime.
It isn’t really a cost savings or investment strategy to only look at the tax savings. How is an investment good if you are paying X dollars and getting 1/3X back? If I’m paying x dollars in interest expense or x dollars in taxes, it is still the same money out of my pocket.
I don’t plan on staying in house in retirement. When I decide where to land, I intend to sell this house and buy my retirement house for equal dollars for cash. No mortgage for me in my retirement which could last 45 or 50 years.
Mary: Great job and great plan. I hope that you will have some capital gain on the house when you sell as well, because that will be tax free (up to $250k).
Thanks for the comment.
My husband and I paid off our mortgage the year our youngest twins went off to college, 2000. I was 49, husband was 54. We accomplished this by paying an extra $100/month to our monthly mortgage, something I learned about in a college Finance course back in 1973!
With 3 children in college at the same time, being mortgage- free enabled me to enroll in/complete an MBA, take ‘early retirement’ and start my own business. We intend to stay in this area/in our home through retirement.
I can’t even put a price tag on what my strategy ended up meaning to our family.
Dale…