MY SON AND HIS fiancée recently purchased their first home. They’ve asked me about things like how to fix a leaky faucet, but they haven’t asked me for financial advice—which is a good thing, because I’ve had very limited experience buying houses.
You see, my wife and I bought our first and only home in 1986. We paid $89,000, putting down $20,000 and taking out a $72,000 mortgage by the time we added in points, fees, taxes and the myriad other costs associated with a loan closing. Our interest rate was 8.5%.
We knew that we wanted to pay off the house early, so we started making extra principal payments. We also refinanced our mortgage twice as rates dropped. The upshot: We paid off the mortgage in 11 years.
But were we financially smart to do so? Remember, this was at the beginning of a long bull market. By paying the mortgage off early, we avoided some $88,000 in interest payments over what would have been the full life of the mortgage. That’s before factoring in the tax deduction for mortgage interest. If you figure that in, the savings might have been $65,000.
Had we had taken the $231.32 per month in extra principal we were paying on our mortgage—equal to more than $30,000 over 11 years—and instead directed it into the S&P 500, that $30,000 would have grown to $75,000 over the course of those 11 years. Throw in perhaps another $8,000 in dividends, and our $30,000 would have been worth $83,000 before taxes, and the sum would have continued to grow from there.
Or, to put it another way, the 8.5% interest rate we avoided, which was even less after our two refinancings, was well below the return we could have earned in the stock market. To be sure, investing in stocks is considerably riskier than avoiding interest by paying down a mortgage. Still, we clearly left money on the table.
So was it a good idea to pay off our mortgage early?
About two months before we made our last payment, the Fortune 500 company I was working for spun off 13% of its employees into a different corporate entity. Many of those employees subsequently lost their jobs.
A manager that I knew—who was making much more than I was as a junior engineer—confided to me that, if he lost his job, he only had about two months of living expenses saved. After that, he would be broke. He wouldn’t have just emptied his emergency fund, but literally he wouldn’t have any money to pay the bills.
Having a nearly fully paid off house gave us a tremendous psychological sense of well-being. My wife and I had also been frugal in other areas of our financial life, and we had both investment accounts and an emergency fund that would have allowed us to weather a long period of unemployment before we would come anywhere close to losing our home. I might lose my job. But I wasn’t going to be homeless, and we weren’t going to have to move and disrupt our children’s education.
So, if my son asked me if he should pay off his house early, what would I tell him? Make sure you have six months of living expenses in a very liquid form, such as a savings account or a money market fund. Make sure you’re contributing at least 10% of your salary to your employer’s 401(k), or more if that’s necessary to get the full employer match.
If you’re doing those two things, feel free to make extra principal payments with an eye to retiring your mortgage early. I have no idea what the stock market will do over the next 30 years. I do know that my son’s paying a historically low interest rate on his mortgage. Still, while I can’t place a dollar value on it, I know the peace of mind that comes from being mortgage-free—and he may be enormously grateful when the next economic downturn comes around.
Kenyon Sayler is a mechanical engineer at an international industrial firm. He and his wife Lisa are extraordinarily proud of their two adult sons. He enjoys walking his dog, traveling, reading and gardening.
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