When Should I NOT Pay Off My Mortgage Early?

Quick summary

• Paying off your house early can be a good move but consider four things in determining the right timing.

• If you still carry consumer debt, are thin on cash reserves, have a low investing rate, or sacrifice too much enjoyment now, the answer is no for now.

• Whether the payoff comes from your income or a lump sum affects the answer.

• Interest rates, the magnitude of the payment, investment returns, and the years remaining impact whether prepaying is worth it and may be counter to your intuition.

• As long as your financial house is in order, doing it because you want to is a perfectly good reason.

Someone recently asked me, “In what circumstances would you recommend NOT paying off our mortgage faster than scheduled??”

I like this question because it presupposes that you SHOULD pay off your mortgage early.

For me the answer is simple: any time you have the cash and your financial house is in order.

Even though I’m biased toward early payoff myself, faster isn’t always right.

There are two ways to make it happen. You can throw extra principal payments at it every month, chipping away over time, or you can write a lump sum check and be done with it.

I’m going to talk about both.

But first, my name is Michael Hollis, and I help people near retirement in Aurora, IL, Chicagoland, and virtually across the US answer questions like how to create a paycheck in retirement.

What follows is general in nature and not specific investment advice.

Let’s start with what I mean by making sure your financial house is in order.

Is Your Financial House in Order?

Here are four factors I use to evaluate whether your finances are in a solid position before even considering early mortgage payoff. These are all parts of creating a firm financial foundation.

Knock out your other debt

• If you've still got credit cards, student loans, car loans, or personal loans hanging around, they’re high interest and suck up significant monthly cash flow.

• Knocking them out first is a guaranteed rate of return equal to the interest rate and payment you won’t be making when they are gone.

• Your cash flow rises with each debt knocked out, giving you more margin and flexibility.

Protect your liquidity

• Even if you're itching to be rid of your mortgage, you can't let yourself end up asset rich and cash poor, meaning you have too much of your wealth locked up in your home and limited ability to absorb the expenses you WILL encounter.

• You need a fully funded emergency fund (for what you can’t foresee) and money set aside for the things you can foresee like home repairs, vehicle maintenance, tuition, taxes, insurance deductibles, medical bills, etc.

There's no need to rush to mortgage liberty if that puts you into a cash crunch.

Make sure you're really investing

Ask yourself these questions:

1. Are you saving more than a token amount of your gross income?

2. Are you capturing your whole employer match?

3. Are those investments diversified?

4. Are they in line with your need for risk-taking, ability to take risk, and tolerance for market swings?

These are just rules of thumb, but if you're not investing 15% of your household income, or you're using investments that are too conservative for your goals, it’s better to get this mix right before you move on to answering “Should I pay off my mortgage early?”

If you’ve got #1 & #2 set, you’ve got much more available for this foundation.

Don't sacrifice too much enjoyment

If clearing the mortgage means no vacations, no dinners out, and nothing fun for four or five years, that's a real cost. You're trading experiences now for an earlier payoff date. Will it be worth it?

Some people are glad they made the trade. Others look back and wish they'd taken the trip.

Just make sure that you’ve considered what’s most important to you now, not just what you think you want retirement to look like. And if you’re married, BOTH of your opinions count equally. It’s a balance.

A Word for My Fellow Ramsey Folks

I say this as one of you.

Gazelle intense was the instruction for Baby Steps 1 through 3. Time and again, callers want to keep that same intensity going through 4, 5, & 6. Frequently, I hear the Ramsey Personalities correct that mindset, encouraging them to switch from intensity to intentionality.

It’s OK to take your foot off the gas.

You weren’t meant to run at a breakneck pace forever. If you’ve reached BS 4, well done.

Enjoy where you’re at and stop going hog wild. Chances are, if you’re married, one of you wants to do this anyway. The more intense of the two of you needs to consider that voice.

So what do we do if we have this foundation in place?

Where Would the Money Come From?

There are two ways to come up with the money to pay off your mortgage early: earn more and spend less, or have a lump sum.

The first is slower and asks you to give something every month. More income usually means more time and/or responsibility, and lower expenses means giving something up. If you’re into a zero-based budget though, it’s a whole lot easier to evaluate the tradeoffs you’re willing to make.

A lump is a little different. It allows you to super-charge one or more financial goals.

Magnitude matters too. It goes faster than you expect. So, the questions at this point are, “What do I point it at?” and “How far will it go?”

Lump sums also have a story behind them, which adds another dimension to the analysis beyond the surface number.

• Inheritance or a gift. The blessing often accelerates goals and can bring real stability. Many find themselves grappling with the “responsible” way to handle it or asking, “What would mom or dad have wanted?” Some look at it as found money and blow it all.

• A bonus or employer stock. These come in chunks and they're tied to your company. It's easy to mentally account for these differently from your normal wages. Some folks have a hard time parting with company stock because they think it could go to the moon or “What will co-workers think?”

• A business sale or your company going public. These are usually HUGE liquidity events, like hitting the lottery. Next to the prospect of another big venture, paying off a mortgage feels anticlimactic and boring.

• Cash you've built up over time. I meet many who have a big pile of cash. Sometimes that's diligence and intentionality, but more often than not, it piled up because they weren't sure what to do with it, or it felt safe, or they were waiting for the right time to “get in the market” but never pulled the trigger.

These are just a few examples of the behavioral psychology at play. We’re not always aware of it either.

I LOVE helping clients uncover these roots with deep questions.

Will It Even Move the Needle?

And now to the numbers question that always gets thrown out.

“If I take what I would pay toward the mortgage and invest it, won’t I make more?”

So, let’s talk about some factors to weigh when considering the “invest the difference” strategy: your interest rate, the number of years, investment returns, and the size of your extra principal payment.

These examples are for illustrative purposes so you can begin to think about how these factors play out. Every one of you is going to have a different mix based on when you got your mortgage, how much free cash you have, and other assumptions these charts are making. 8% and 4% returns are assumed and not actual returns.

Situation #1

Take an $85,000 balance at 3% with five years to go. Put an extra $250/mo. toward it and you'll finish about 9 months early and save right around $1,000 in interest. Invest that same $250/mo. instead and you might end up with a couple thousand dollars of growth. Oh, and don’t forget that you’ll probably owe taxes on that investment gain.

So technically, you could get a little more from investing depending on the situation.

But here’s the thing, with a short time horizon, will either one change your life?

How should I “invest-the-difference”?

If you have a short time left on your mortgage, the return from stocks might not be worth the risk, so you could turn to something like a CD that gives you a fixed rate and protects principal. That lower risk also comes with lower returns, as you can see above.

The longer you have left on your mortgage, the more risk you might be willing to take with the invest-the-difference strategy. Just remember that past performance is no guarantee of future returns.

Situation #2

Let’s change the loan picture and see how these factors react.

At $275,000 and 6.5% with twenty-five years remaining, that same extra $250/mo. saves about $78,000 in interest and gets you out about six years sooner.

If that $250/mo. grew at 8% over the same stretch you'd have roughly $76,000 in growth.

The comparison leaves out taxes. After long-term capital gains tax (assuming 15%) you'd net somewhere around $64,600. The interest you save is guaranteed and it isn't taxed, and investment growth is neither of those things.

How much do these numbers influence your decision? I’m curious to hear your thoughts, so send me a note if you want to share privately.

How does a low fixed-rate mortgage help you?

All that said, a low fixed rate over a long period of time works in your favor. Your payment stays the same as other expenses climb, so the real cost of that debt shrinks year after year as inflation rises.

Your income is likely rising too, which means the debt takes up a lower and lower percentage of your cash flow.

A 3% mortgage is a reasonable hedge against inflation and there's nothing wrong with keeping one. But how many of you are still getting 3% mortgages these days?

What does “invest-the-difference” assume?

The invest-the-difference argument holds only if you actually invest the difference, every month, and don't bail for the whole term of the original comparison. When considering this strategy and especially when it’s based on a decade or two of consistently doing so, ask yourself:

• What are the chances I will stick with it to the end?

• What are the unexpected events that would change the plan?

• How long will I stay in my home?

• What happens if we have an economic crisis?

When Should I Pay Off My Mortgage Early?

Pay it off when your financial house is in order and when you want to.

Don’t let people shame you for making a decision that isn’t solely based on math.

I've felt this one myself. Here’s my experience.

Not having a mortgage payment changes the life decisions you make.

Less debt means less risk, and less risk means you might say yes to other risks you’d like to take but you think are out of reach, like leaving a job that isn’t what it used to be.

There's a retirement angle here too.

Housing is usually the largest line in your fixed expenses, so eliminating it before you retire shrinks the gap your portfolio has to cover for the next twenty-five or thirty years.

It's Not All or Nothing

You don’t have to choose between paying it off tomorrow and doing nothing.

You can put a chunk of that lump sum against the principal without emptying the account. You can add a modest amount to the payment as long as you still have margin and room for enjoyment. You can leave it alone now and see if it makes sense next year.

How I Help

At TapestryFP, this is the kind of decision I work through with clients.

We look at your real numbers, yes: the balance, the rate, the years left, where the money would come from, and what else it could be doing.

But that goes hand in hand with equal weight on the part a spreadsheet can't answer which is, “What’s your WEALTH for?”

We charge a flat fee, so our advice doesn't change based on whether you keep that money invested with us or send it to your mortgage company. And because we prepare taxes for our ongoing planning clients, we help you see the tax picture too.

If you're sitting on cash or wondering whether to start throwing more at the payment, let's talk it through.