If you had been handed a million dollars, would you pay off you mortgage? I wouldn’t. Paying off their mortgage seems to be the ultimate goal for most people on their FIRE journey. I look at it otherwise. If I had been handed a million dollars, I would not put a dime extra in additional paybacks. This post is all about why I don’t pay off the mortgage.
What is a mortgage?
Why are you paying the bank every month for the mortgage? Is it a fee you have to pay the bank and once you have paid it back you are through? No, you pay rent on money you have borrowed from the bank. The money you have borrowed for the purpose of buying real estate. But disregard the purpose. It is simply borrowed money.
The rate you have borrowed this money is not daunting. I tried to do some Google research and as far as I could tell 4% seems like an ordinary rate in the US. In Norway an usual rate is just below 3%. Understandably it is tempting to get rid of these yearly fees that you pay to your bank. But let me give an example that shows why I want to keep paying my interests.
Pay off the mortgage — or not..?
Say you have a mortgage for $10,000. You pay 4% of this every year. That is $400. Then you for some reason receive $10,000 in cash and are given the choice of paying off the mortgage or not.
But you have an alternative that I find more attractive. You see, I like to say that not having to pay 4% in interest is equal to receive 4% in returns. So if you paid off the mortgage you have $400 more the next year because you don’t pay interest anymore. And that is 4% of the $10,000. But instead of paying back the mortgage you can instead use the $10,000 and buy index funds.
The stock market, using the S&P500 as a benchmark have returned an average of 8% historically. That is twice the return compared to paying off the mortgage. This is a simplified example, but say you placed $10,000 in the S&P500 and then each year sold off the returns. 8%, $800. Then you can use that money to pay the interests on the mortgage. And you are left with a profit of $400.
… it depends
The other day TheGladiator created a poll where he asked the followers whether they would pay of their mortgage or not if they had enough money. 59% of the 556 voters said they would pay it off. And TheGladiator makes an important notice saying that “this isn’t only a financial decision but also a psychological, emotional, mental one. Judging by the comments many people seem to agree with him there.
Even though I said initially that I would not a dime extra towards my mortgage. This may not suit everyone. Everyone is different. For me I enjoy investing in the stock market and I don’t struggle with my mortgage payments. If paying off the mortgage means that the next year all your worries are lifted from your shoulders. Then you should perhaps pay off your mortgage. If paying off the mortgage means you have the necessary spending power the next year, Yes, then perhaps paying off the mortgage is good for you.
If you are like me, follow the money
So as you see the answer to paying off the mortgage or not is “it depends”. For me the choice in this matter is between Mortgage or Investing. And I will alway go for the highest risk adjusted returns for my money. If you are like me, follow the money and choose the highest ROI. This also mean change direction if the condition changes. If your mortgage rates changes and you all of a sudden needs to pay 9% interests. Then your highest returns are by paying towards the mortgage.
Have you considered this? What do you prioritize? Please let me know.
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