BiggerPockets Money Podcast - 554: Should I Pay Off My Mortgage or Invest? (We Did the Math)

Starting point is 00:00:00 When you're on the path to financial independence, there's this big debate. Should I take this money and pay off my mortgage, or should I take that money and put it in the stock market? So today, Scott and I are going to have a lively debate because one of us feels like you should keep your money in your mortgage. And the other one thinks the stock market is the way to go. Can you guess who is right? Me! All right. Hello, hello, hello, and welcome to the Bigger Pockets Money podcast. My name is Mindy Jensen. and with me, as always, is my totally wrong about mortgages, but I still love him anyway. Co-host, Scott Trench. Thanks, Mindy.

Starting point is 00:00:33 Great to be here. This topic is of simple interest to me, and I look forward to discussing it with you today. All right. Oh, that's right. Bigger Pockets has a goal of creating one million millionaires. You are in the right place if you want to get your financial house in order because we truly believe financial freedom is attainable for everyone no matter when or where you're starting, including whether you have a mortgage and I can't decide whether to pay it off or invest.

Starting point is 00:00:58 In this episode, we're going to talk about how you should be looking at your portfolio to determine when and if paying off your mortgage is ever a good fire decision and whether the fire math supports that. We're going to discuss a quick refresh in how to calculate your five number. We're going to talk about how to determine when and where some folks may consider paying off the mortgage or not. And we're going to discuss how that can affect your timeline to financial independence. So Mindy and I obviously disagree. A lot of this will be a debate. Mindy, I would love to open this up by hearing why you shouldn't pay the mortgage. I think you have prepared a lot of math and a big argument for that, which I will dissect shortly.

Starting point is 00:01:36 Okay, so I have actual real life examples for why you should not pay off your mortgage. But before I give that, I want a caveat. This is only for people who are considering paying it off versus considering keeping it. If you have financial trauma in your past that just does not allow you to sleep at night without having a mortgage paid off, then this conversation is not for you. This conversation is for the people who truly aren't sure should I pay off my mortgage or should I invest. So, Scott, my true life story. I was born in a small town. No, okay.

Starting point is 00:02:15 Fast forwarding to 2019, back when interest rates were still really low, I was able to purchase the house that I am recording from right now for $365,000, which was a huge discount because it was gross, as my houses tend to be. It was a smoker's house. So they had smoked in this house for 40 years. The carpeting was like just holding in all this stuff. It was horribly outdated. And nobody wanted this house. So it was already sitting for a long time. The sellers were getting very anxious. And in order for me to be able to get it for such a reduced price, I had to be able to close quickly. So I rated my 401k in the form of a loan, not in the form of cashing it out. I rated my 401k, my husband's 401k. I got a line of credit on my other house that I had been living in

Starting point is 00:03:09 and I sold a collectible car to gather up all the cash so that I could pay cash for it and close very quickly. You didn't sell your Tesla stock? I sold my Accura NSX. Got it. Okay. I think we sold Tesla stock to buy the Tesla car. But anyway, so we bought in September of 2019 and then six months later, we cash out refinanced. We pulled out 80% of the value of the home and grabbed that cash. So now we have a mortgage. Our mortgage is at 2.875, and I know that interest rates have gone up, but this is what happened with me. So we have, we pulled out $319,000, and since then, we have paid $31,500 in interest approximately. But we took that $319, we put some of it back into pay off the 401K loans. we invested $152,000 in a variety of things.

Starting point is 00:04:15 That $152,000 is now worth $322,000, which is a gain of about $170,000. These were, we invested mostly in funds like VTSAX and VGT, which is Vanguard's tech fund. We also bought 40 shares of Tesla. Now, Tesla has far underperformed the funds, including VTSAX, but VTSAX has far underperformed the VGT that we put it in. If we had put it all in VTSAX, we would only be up $140,000. And also note that we took that $150,000 and paid off the line of credit and the 401K loans and all of that. So if we'd invested the entire $319,000, we'd have a whole lot more. But we would also have paid a lot more interest because the home equity is a variable

Starting point is 00:05:06 rate. And we were just like, yeah, I want to close this out, pay this all off. So I am up $170,000 simply because I have chosen to have a mortgage. And actually, if we're going to be fair, I'm up 140,000 because I've paid $30,000 in interest. So that is my argument, Scott. But I will also caveat that I have heard people say, oh, the reason that I want to pay off my mortgage is because if I didn't put the money into the house, I would spend it. And I'm technically not spending it. I'm investing it. All right. How are we doing? Is it time for me to react to? It is time for you to react. Let's get something off the books immediately.

Starting point is 00:05:45 If you pay off a low interest rate mortgage and the stock market, for example, an index fund returns anything close to what it's returned over the last hundred years on a go forward basis, you will have less wealth at the end of 30 years, investing in paying off your mortgage than investing in the stock market. So no one is arguing against that. the only way you'll have more wealth paying off your mortgage is if the stock market goes nowhere over the next 20, 30 years, which I don't believe. So my argument is not for how to amass the largest net worth number. My argument for paying off the mortgage has to do with the math of fire. So let's use your mortgage specifically as an example here. You have a mortgage of $319,000, right? Okay, $319,000. And I believe you said the mortgage rate. was 2.875%. Okay. So your monthly P&I payments are $1,324, $1,324 times 12 months,

Starting point is 00:06:51 times 25, which is the 4% rule. So a big implicit assumption here. Here, I'll actually take one step back, times 1,324 times 12 is $15,88 per year. Now, to fire, one typically, needs, the rule that we always come back to is the 4% rule. So one would need 25 times $15,888 from their portfolio in order to comfortably retire using the 4% rule. That implies a balance of $397,200 in your portfolio of stocks and bonds in order to distribute the $15,8888 per year you need just for P&I. So if you're close to fire, you don't have this problem because you're so far past fire. You have so much more wealth than you need to feel comfortably retired that you can just optimize for even longer term wealth and not ignore this problem in general.

Starting point is 00:07:51 But someone who is close to FI would accelerate their journey by paying off the $319,000 mortgage, even at that 2.875% range early because it would reduce the total balance of wealth they need. to fire by $70,000. How's that for some interesting fire math here? Now, that gets even more extreme, obviously, you have a low interest rate mortgage, but if you have a 7% mortgage, let's do the math here for this one. So that's a $2,122,000 P&I payment. So $2,12 times $12,000 is $636,000. So paying off this $319,000 mortgage balance at 7% accelerates your FI journey by an incremental 320-some-odd thousand dollars. And that is the phenomenon that really has been interesting to me over this time is, yes, there's an opportunity cost in 30 years.

Starting point is 00:08:53 Someone may have less wealth. But is even that opportunity cost as big as we think? Because when we think about the fact that someone needs to generate $25,000 per year on that $319,000 mortgage at 7%, for example, is the opportunity cost with the stock market really that large? There are tax considerations one has to factor in here. In order to generate $25,000, one has to realize income in some form, whether it's a capital gain or dividend or ordinary income.

Starting point is 00:09:24 Going in the most conservative case, a capital gain might be taxed at a 10 to 20% rate. For a fireperson, it's probably going to be in the higher end of that range. let's call it 20% plus your state tax, four or five percent. So now your 10% stock market return is really only 7.5%. So you have to generate a 10% pre-tax return to pay the 7% tax rate on your mortgage. A 7.5% return that's highly volatile in the stock market and maybe not certain, maybe not something that you really want to plan on or guarantee yourself. That's not enough of a spread for me to pay off, it's compared to a guaranteed reduction, a guaranteed 7% interest rate on a mortgage. And following that math, the house I'm sitting in and recording this podcast from is one that I

Starting point is 00:10:14 purchased this year and I chose to not use a mortgage. I chose to just buy it in cash instead of investing in the stock market or an alternative because of that concept here. If I was going for the largest possible long-term net worth number, no way would I have that. I believe I could have gotten a spread in real estate or something else compared to buying this house. But I have peace of mind, a guaranteed return here, and it's a two-way door. This rescission is not irreversible. I can always take out a mortgage if interest rates go down in the future and reinvest that in something else like real estate stocks are an alternative. So that's my fire math. I think I have two more points here and then I'll shut up on my monologue. I think that I want

Starting point is 00:10:57 a caveat this as, if I was starting over my journey to fire, there's no way that I would say, oh, I'm going to buy a house and pay down my mortgage, right? This is not a good tactic for someone starting on their journey, but I think that for someone who's close to fire, even if they have the 2.85% mortgage, that paying that off may be the thing that actually moves them over the edge and gets them comfortable with financial independence. There's a model that I need to build here to calculate that. I wanted to have it done for today, but I didn't have a chance to do it. And sometimes I've delayed on these types of discussions for months and months and months until I actually get around to building this thing out. But I know that once I build that and model it out,

Starting point is 00:11:39 that it will show that a new person starting out from zero or the first 100, 250K and looking to move toward fire should not pay off their mortgage if they want to maximize their chance to get in there quickly. And I know that people who are close to fire will be able to finish the journey per the 4% rule, a little faster in many cases if they choose to prepay their mortgage. So how's that for? I hear what you're saying. And I have some questions. All right. We do have to take a quick break to hear a word from our sponsors. But when we return, we're going to continue getting into the nerdy pre and post-tax math of paying off your mortgage versus putting it into alternatives like high-yield savings accounts. Tax season is one of the only times all year when most people actually look at

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Starting point is 00:15:13 So first off, you said if you were just starting your journey, you wouldn't pay off your mortgage. But if you're close to fire, you would. What does close to fire mean in this conversation? Let's go back a couple weeks to Emily and Justin from the middle class trap episode here. I think that was episode 543 of the Bigger Pockets Money Show podcast. So we're talking to them. They're $1.5 million net worth. Their mortgage is probably in that 2.85%.

Starting point is 00:15:43 range, maybe a little higher, maybe a little lower, but in that low interest range. And they're like, you know, how do we get out of this portfolio that's not producing any cash flow or lessen the pressure on ourselves to just earn a bunch of income? Well, that's a really compelling position or a really compelling situation to say, you should just pay off the mortgage potentially. Because if the goal isn't the longest, the highest possible long term net worth, but the feeling of financial independence and unlocking bits of the portfolio, that's an easy lever, right, that unmox 20 or 25 years, potentially, of a lower demand for income generation for that. During the best years of your life, you have a lot less pressure on your household

Starting point is 00:16:23 to generate to be, you know, to generate income to maintain a cash flow positive situation. So I really like that. Also, I want to call out that some folks run the opportunity cost on paying off the mortgage incorrectly because they'll say, oh, you take that $300,000, you invest in the stock market, and you get this huge number. Well, that's a lot of the money. Well, that's not a fair comparison because what you're doing is you're taking that 300,000 and you're prepaying the mortgage. But then every year, Mindy, you can invest the $15,888 in the stock market. So you get a good chunk of it back. There's still an opportunity cost at the end of it, but it's not $300,000, $319,000 compounding at 10% for 30 years versus nothing, right?

Starting point is 00:17:06 You can still invest in the stock market on the alternative there. And so it's a much lower spread than a lot of people compute back of the napkin in terms of that opportunity cost. So anyways, in that situation, I think that there's a very good argument to be made for paying off the mortgage. And I think that argument is only that much more powerful for folks like me who bought a house in 2024 or 2023 with the higher interest rate environment. I will give you that the higher interest rate environment would definitely give me a different thought process. And you said something, it isn't 319,000 versus nothing. And I think that's really important to point out. I think a lot of people don't calculate these numbers correctly.

Starting point is 00:17:48 They think in terms of absolutes. It's either 319 or it's nothing. And that's not true. And I am just as guilty as anybody else of thinking in more absolutes. Scott, what is your opinion of taking the difference? let's use my $1,324 a month PI payment. And let's say I wanted to make a $1,500 a month payment in order to pay that off. What is your thought of making the $1324 and then taking the 176 and putting it into a high

Starting point is 00:18:23 interest checking account or a high interest savings account so that I have access to the money? I'm still making this additional payment. I'm just not paying the mortgage company that. I am making more in interest. Now, somebody pointed out that you are going to pay taxes on that interest. Yeah, that's my big problem, right? So in Colorado, right, you take a, like someone who has the ability to generate $319,000 in cash is likely in a moderate to high income tax bracket.

Starting point is 00:18:58 So someone who's capable of making this choice, which is most of the people who we're talking about on this episode, right, a third of the people listening to Bigger Pockets money are millionaires and are likely to have some version of this problem in their lives, right? So this is not for everybody. This is not for somebody who's starting out. You know, you're like, oh, privilege to have to discuss paying off the mortgage you're investing. This is for folks who have the choice to make there. But let's say your household, Mindy, you're talking about this. You're going to earn 5% if you're doing a good job in your high yield savings account. That would be a good high yield savings account. You have to probably move your money pretty

Starting point is 00:19:33 frequently to sustain that because they always dip and dive in various banks. I think Ally right now in my account is like 4.75 or something like that. Let's say you're good and you get 5%. In Colorado, the highest tax bracket is 43.8% when we blend federal income tax, state tax, Medicare, Medicare, and Medicaid, and then Social Security. Okay. So that is going to cut your return from 5% to a little over two, a little over two and a half percent in terms of the yield on that, which is lower than the interest rate on your mortgage right now at 2.85 percent. It'll be some difference there. You, like probably most other people in the situation, probably just take the standard deduction, so you're not itemizing your mortgage on this. So it's a true net negative

Starting point is 00:20:25 arbitrage to put that money in a high yield savings account, in my view, compared to paying off the mortgage in a situation like yours. So in my situation, because we're talking such low interest, I would still, if I was in this position of I wanted to pay off the mortgage earlier, and I used to be in this position, and I am no longer, but I would still put it into the interest-bearing account versus putting it into the mortgage for the sole purpose of being able to access those funds if I needed them. Once you put them into your mortgage, you have paid down or paid off your mortgage. The only way to tap into your home equity is a home equity loan, another mortgage, or a home equity line of

Starting point is 00:21:13 credit, all of which come with a much higher interest rate than what I am currently paying on my mortgage and even what I would be paying when I, with regards to putting it in the account. So I would say, if you are in this position where you are not financially independent, you don't like debt, and you have a lower interest rate mortgage, consider putting it in there, even giving into account Scott's tax bracket math, still put it in the high yield savings account. That's what I would do just because I want to be able to access that money. Yeah, well, look, I just look at it as one pool of money. I'm a little bit more cold and calculating in the way I think about the assets here. It's just, let's say this person, like I said, $1.5 million, like our couple, Emily and Justin,

Starting point is 00:22:01 from that episode a few weeks ago, right? Well, like, how do you want that to be distributed? Right now, it might be $400,000 mortgage against $600,000 home plus some stock investments in various retirement accounts, plus some cash, plus a little bit of real estate. Well, it's just how do you want that distributed? And I'm arguing basically for allocating some of that pie to the paid off house in the situation because of the reduced pressure it puts on the rest of the portfolio to generate income, the feeling of freedom that it will engender and the better tax advantage returns than putting

Starting point is 00:22:34 all of that in a high yield savings account. Now, if Emily and Justin or whoever's listening to this is saying, I want to be an entrepreneur, I want to go buy a business or I want to buy another rental property and go flip it or do something that is generating truly high returns, cash all day. But if you're a passive investor that just wants a high, wants a higher amount in savings, I think there's a potential mistake being made there because you're actually getting a, you're negatively arbitraging the interest rates after tax considerations are taken into account. And I think that, you know, if you can do with a lower, like, I have a paid off house, Mindy, I can get a HELOC anytime I want.

Starting point is 00:23:12 I don't need to have quite as much cash in there. In the event that I needed cash, yes, I'd be paying a higher interest rate to borrow a HELOC, but for the rest of the time, I'm not paying 7% interest on my mortgage. So I think that there is a very good odds of that being a really positive spread there. So I think that that's the way I would think about the, that's the way I would politely debate your point there. And I appreciate that. I appreciate the politely debating, even though I called you totally wrong about mortgages at the very beginning of this show. I do see argument on both sides.

Starting point is 00:23:52 And I can understand why somebody would want a paid off mortgage. And in the current interest rates, I just wrote an offer on a house for a client and they said, we're going to pay this mortgage off in six years. We don't even care what the, in fact, they took out a seven-year arm because a seven-year adjustable rate mortgage is less expensive interest rate-wise than a 30-year fixed or even a 15-year fixed. So this is another point here, right, is around the other advantages that come with the decision to pay off the mortgage early, like the ability to use an arm.

Starting point is 00:24:29 Nobody, if you're not, if that's not your plan, that doesn't make any sense, right? The only, so why would you, why would you get in an arm if you're not intending to pay off the mortgage, right? I mean, there's just, you're exposing yourself to a lot of interest rate risk. on your lifestyle to a large degree. I mean, yes, I know that there's people who will give me a mathematical argument for that. But that's not something I would do. I don't really, the home is a little bit different for me than the other parts of my investment portfolio now that I've decided where I want to live long term. But there are other advantages as well, which include things like insurance.

Starting point is 00:25:00 So my insurance policy in my house is actually cheaper than the insurance policy on some of my rental properties, which are maybe a lower value in certain situations because I can just choose to have a much higher deductible, which is a couple percentage points of the home value, because I only need catastrophic insurance on the house. The lender might not accept that on a loan. So I have a much cheaper insurance policy, for example, with the paid off house. So there are other advantages that accrue as well, getting those expenses as low as possible. All right, we got to take one last break, but stick with us. You don't want to miss a couple of practical additional considerations that have to do with paying off the mortgage early. While we're away, it makes a lot of

Starting point is 00:25:42 sure to hit that follow button so you never miss an episode of the show. Or if you're watching on YouTube, hit that subscribe button and give us a thumbs up. Tax season is one of the only times all year when most people actually look at their full financial picture, including income, spending, savings, investments, the whole thing. And if you're like most folks, it can be a little eye-opening. That's why I like Monarch. It helps you see exactly where your money is going, and more importantly, where your tax refund can make the biggest impact. Because the goal isn't just to look backward, it's to actually make progress. Simplify your finances with Monarch. Monarch is the all-in-one personal finance tool designed to make your life easier. It brings your entire financial life, including budgeting,

Starting point is 00:26:16 accounts and investments, net worth, and future planning together in one dashboard on your phone or your laptop. Feel aware and in control of your finances this tax season and get 50% off your Monarch subscription with the code pockets. What I personally like is that Monarch keeps you focused on achieving, not just tracking. You can see your budgets, debt payoff, savings goals, and net worth all in one place. So every decision actually moves the needle. Achieve your financial goals for good with Monarch, the all-in-one tool that makes money management simple. Use the code pockets at monarch.com for half off your first year. That's 50% off at monarch.com code pockets.

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Starting point is 00:29:31 private finance Friday. This offer is first come first serve and will be given to the first ten. BP money listeners. To receive the offer, please email our events director, Alex, at conference at biggerpockets.com, and let her know you heard about the offer on BP money. Okay, now let's get into the show. Yeah, I only want to be tapping my insurance policy if the place burns to the ground or I have a huge disaster. I don't want to be tapping it for a $20,000, you know, a problem there. That's not, you know, I can insure against that and save thousand, two thousand, several thousand a year on my premiums by increasing that deductible to a point

Starting point is 00:30:11 that would not be allowed by a lender. Yes. And in fact, I have experience with that because I tried to increase my deductible to $10,000 and my lender said, oh, nope, we don't like that. You can only have a $5,000 deductible. And I thought, well, what does it matter? I have the funds to pay the $10,000, but because they hold the mortgage, I now have a more expensive homeowners policy because I chose to have the mortgage. And that's a good point, but I'm still up $140,000 with my investment. Yeah, look, I mean, yes, if you go back, it's all about what you believe going forward. And I believe that I believe that the stock market is going to return close to its historical average of 10% per year over the long run. I believe,

Starting point is 00:31:03 that my pre-tax net worth will be higher if I invest in the stock market instead of paying off the mortgage, right? I believe that post-tax, the opportunity cost is actually going to be pretty low, and tax brackets for, you know, capital gains and dividends are going to go up, not down, over 30 years, which is a complete guess, but just how I feel about it, making that spread even lower. And I believe that, again, that opportunity cost is overstated by a lot of people who are silently arguing against me because they did not factor in the fact that I will be investing the cash flows every month when I don't pay the principal and interest payment. I'm investing that in the stock market or in alternative investments that are likely to perform reasonably well.

Starting point is 00:31:52 So, again, that's just my position on the situation. And it's a privileged position to have, but it's also just part of the fire world. This is a decision that most of the people listening to this podcast either are making currently in favor of keeping their mortgage or we'll have to make in five or ten years when they begin to approach fire. And I think that it comes down to what is your personality type? Like Scott and I are very, very different people. He is very cerebral, very calculating very much, you called yourself cold. I won't call you cold, but you look at things black and white. I am far more passionate and fly by the seat of my pants. And it just depends on what your risk level is, what your comfort with debt is, and what your brain will allow you to

Starting point is 00:32:46 think about. And I also want to keep reminding, you know, the math here also says that it should be different at various stages in the fire journey, right? Like, it's kind of, I'm not going to sit here and tell someone who's got a median or, you know, middle, upper middle class income, and starting with less than $100,000 in wealth, that they should pay off their mortgage as the fastest way to pursue financial independence. That is not true, and that should not be the takeaway from this. That's a, that's fine advice from Dave Ramsey. It's a good, slow, and steady approach, but that's not what I'm saying. I'm saying that someone who is close to probably well over the million dollar net worth mark may find that paying off the mortgage

Starting point is 00:33:26 accelerates their completion of the financial independence equation, having a portfolio that is 25 times the amount of their annual household spending. Paying off the mortgage may be a big step in completing and satisfying that equation earlier than not paying it off. And you should really run the math for yourself there. Okay. Well, you know what? I want to hear from our listeners.

Starting point is 00:33:49 have you paid off your mortgage or have you specifically not paid off your mortgage and why? Either direction. No judgment, Scott and I will not judge you. And none of our listeners, if you share this in the Facebook group at Facebook.com slash groups slash BP money, none of our listeners will make fun of you if they do tag me and I will come in and boot them out because this is definitely a personal finances, personal, kind of the height of. of the personal finances, personal conversation. If you want to pay off your mortgage, ultimately, I'm not making your mortgage payments for you. So go ahead and pay it off.

Starting point is 00:34:27 Scott's not making them either. So you can keep it if you want. And for the record, despite the math that I just described over the fire, I only paid off the mortgage in my primary, which would have been at the higher interest rates in today's environment. And I have not paid off the mortgages on my investment properties. Now, part of that is because I still work, and I'm well past my fire number so I can take the better long-term returns that come with leverage on an overall basis. But, you know, I, so I don't want to tell folks that I necessarily would have done this if I had a 3% mortgage on my existing house personally. But it definitely made sense to me at 6.5, 7% to just pay it off. Okay. Well, I'm glad that you caveated all of that.

Starting point is 00:35:12 Again, listeners, we want to hear from you and we want to hear what you're doing and why. And even if just I don't like debt is the reason, that's a valid reason. Like I said, it's personal finances, personal. All right, Scott, I think we have shared both sides of our story. Is there anything else you'd like to add before we skedaddle? The only thing I want to add is that I think that a lot of people can't help themselves. Maybe I'm a part of this group and say, yeah, I know the stock market returned 10%-ish on average compounding over the last 70, 100 years. But really isn't going to do that over the next 20 to 30 years.

Starting point is 00:35:51 And if that's in the back of your mind as well, that continues to be another, you know, little, little, little extra oomph on the paying off the mortgage early argument there. Yeah. Like I said, personal finance is personal. So make the decision based on something, not just, oh, Dave Ramsey told me that the paid off house is the new BMW or whatever his thing says. If you don't identify with paying off your house, then don't. Keep your mortgage. If you do, then, you know, take Scott's side. I'll still like you. I think in 2024, we say the paid off home is the new Rivian.

Starting point is 00:36:27 Ooh, the new Rivian. Daphne wants a Rivian. She's like, Mom, when I turn 16, will you buy me one? I'm like, no. All right. Just as a reminder, we have a website, BiggerPockets.com, where you can go to learn everything there is to know about real estate investing. And we will see you there. Scott and I are in the forums frequently. So give us a shout out, give us a tag, and we will come in and have a conversation with you. Scott, should we get out of here? Let's do it. That wraps up this episode of the Bigger Pockets Money podcast.

Starting point is 00:37:00 He, of course, is the Scott Trench, and I am Mindy Jensen saying, bye-bye, Dragon's Eye. Bigger Pockets Money was created by Mindy Jensen and Scott Trench. This episode was produced by Eric Knutzen, copywriting by Calico content. Post-production by Exodus Media and Chris Mickin. Thanks for listening.

BiggerPockets Money Podcast - 554: Should I Pay Off My Mortgage or Invest? (We Did the Math)

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