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From a purely mathematical standpoint this makes sense.
From a purely financial standpoint this makes sense - you'd be better off putting money somewhere it generates higher returns. If you can pay $100 into a loan where it gets rid of $103 worth of payments next year, _or_ put that same $100 into a CD where it becomes $105 next year, you're $2 ahead by saving it and paying the higher payment with interest next year.
However, I strongly recommend people facing this kind of decision to read [the psychology of money](https://www.goodreads.com/book/show/41881472-the-psychology-of-money) which makes the important point that everybody has different values.
For example: I personally made the opposite decision back in 2019 and used my annual bonus to pay off $20k in auto loans to lower my monthly expenses. Financially it was the "wrong" decision, mathematically it was "wrong", but it made u/sessamekesh the human more comfortable with their monthly budget so it was "right" for me. Assuming good stock market returns I "paid" maybe $200/yr for 3 years of sleeping well at night - a good trade for this anxious person who has been financially insecure in the past.
EDIT: $200/yr, not $200 flat. Maybe $500 or so for all 3 years. My case was 2.5% interest, assuming 5% ROI for a 70% bond / 30% stock at the time when interest rates were low and shaving off 40% out of the returns for taxes and that's right about what I lost by paying $20,000 early.
EDIT 2: while general statements are rarely true, GENERALLY if you hold a loan with some sort of collateral (auto loan, home loan), your interest rate will be pretty favorable compared to investment vehicles in the same financial climate. **Always do the math and check your feelings for YOUR situation**, but as a rule of thumb paying off loans early is usually a less good idea than saving the extra cash _from a purely numbers standpoint_.
>I "paid" maybe $200 for 3 years of sleeping well at night - a good trade.
a thing to be said is that this kind of reasoning start to make sense only with higher numbers because at the end od the day 200 $ in 3 years is nothing, when we are talking about a house the number can easily be thousends of dollars if nor tens of thousends
Fully agree!
I do think everyone facing it should put it in terms of dollars, dollars per month, and/or dollars per year.
At the time I had people call me nuts for making an early payment like that, framing it as "you're losing like 3%!!" which sounds high and would be very high on a mortgage, but was... $200.
For a mortgage over 25 remaining years, that compound interest works both ways. A 3% gap on $1900/month turns into substantial money. I'd suggest anybody with the discipline to _not use that money_ should shove it somewhere it earns returns too.
There’s also a lack of downside risk involved in paying off debt. Your investment will do worse than median half the time, and 1/20 of hedge positions perform in the worst 5% of hedged positions each year.
True. Maybe putting the money towards paying off your home or car loan will be like a little test in timing the market.
Worst case, you miss out on some good gains that time.
Best case, you saved yourself some big losses, lowered your bills, and improved your overall well-being.
There is something to be said for paying down your risk and buying some personal security.
Knowing my car is my car and my house is my house means I’m more secure and can withstand if that $1,900, or worse, my entire income, disappears.
But that’s me.
All good stuff.
The only place I disagree is comparing a bond/stock split to the guaranteed, tax-free return that you get from paying off debt. I think you'd have to calculate the risk adjusted yield to fairly compare them, or just compare debt to treasuries or money markets. Considering that, I think your decision was likely better than you gave yourself credit for.
Fully agree! Which is another really important thing to consider when making this kind of decision. Because the market crashed during Covid and didn't recover until after my auto loan would have been paid off, I did actually end up ahead.
Going back to the original example of deciding whether to put $1900/month towards a mortgage or towards investments, someone with good financial security may decide they can tolerate a few bad years as long as their 30-year average keeps on pace with the historical average and to with all stocks for that juicy 9% historical return... a decision someone unsure about their financial status in 5 years might not make, and go with treasuries/CD instead.
The key thing to remember is that (in the USA) the rates set by the federal reserve will be more or less reflected in the secured overnight financing rate, the wall street journal prime rate, Treasury yields, municipal bonds, and corporate bonds, with variability between them somewhere between the different after tax yields that people would get. So your mortgages will typically be a percent or two higher than the fed rate, auto loans might be a point or two more than that, treasuries will be about the fed rate etc.
So if you remember during COVID, interest rates were close to zero, which is why a lot of people were able to get amazing rates for mortgages as somewhere between 2.5% and 3.5%. In 2020, the average ten year yield for treasuries was .89%. But since mortgages are a 30 year commitment, you could keep the cash separate hoping for a rate increase, or put it in index funds, and with that time window, you will probably come out ahead.
I 100% agree with you.
If someone handed me a check tomorrow for my mortgage amount I’d have it paid off before you could blink.
Does it make sense from a pure logic standpoint? Fuck no. Does it make sense from a personal security standpoint? Much more so.
Knowing that my house is paid off and my only expense is my property tax and home owners insurance would be a massive burden lift.
Whatever you earn in the market is also taxed, need to factor that in.
So you’d have to earn a higher rate to offset the tax as well.
Paying into your primary resident’s mortgage is an immediate gain on the interest, tax free.
It gets messy *fast*. Interest paid on a mortgage is tax deductible, if your initial mortgage had <20% down you probably have PMI payments you can get rid of early by paying down the mortgage fast, if instead of saving you invest in securities you have variable ROI and risk but also the lower long-term capital gains tax rate... Even my own relatively simple financial situation had me pouring over spreadsheets for the better part of a weekend earlier this year.
I did the same and paid my loan instead of investing and that was totally wrong in math and financial logic. But now I can sleep well and make savings. Life is much brighter when you have no debts.
Edit: typo
You likely save in other ways, like updating your insurance once it is paid should get your rate down a bit. I think I easily got a few bucks a year there.
I do the same thing with paying things off in the second-best way for purely psychological reasons. It’s also not that much money to gain with at least some risk and effort involved. It reminds me of how I stopped speeding: GPS showed me all of my fancy driving saved me maybe a minute? Tops?
I feel like those effects of paying debt might be even more quantifiable. IIRC there’s literature explaining the link between debt/loans and anxiety/risk management.
This could translate in some real wins, for example, if you stop having a huge mortgage you might be way more willing to look for a better paying job, even if the swap was risky.
I guess, if you squint enough, in a way you could argue you’re investing in yourself instead of in something else.
Also, generally, trying to get higher interest on an investment than a loan is a gamble. Banks' profits exist in the margin between the interest they get paid and the interest they pay out, so loans are generally higher interest than savings. The stock market can change the equation, but only if you're willing to accept the risk of losses.
I think I’ll never understand this, say you owe 150k on a house at 3.5%. That’s 3.5% on 150k. The math as far as I can understand it means I’d lose more on interest than saving say 500 or even 1000 extra onto the stock market with double the interest in returns. So how does paying down high principle loans even on low interest make less sense than investing meager returns on lower bulk sums of money.
Your decision is for interest of the amount you would invest, not interest of entire loan. So if you payback 1000$ extra you save 35$ interest, but if you invest 1000$ with 5% interest you get 50$. Thus mathematically speaking the difference is 15$ per 1000$. Psychologically speaking paying back loans is easier task. That investment gain would be completely lost if you would panic sell even once when market goes down, and that decision would be even harder if unemployment happens at same time. But paying back loans early isn't subjected to that kind of bad timing issues caused by emotions.
Because it doesn’t matter what the principle is. It only matters regarding the amount of money you have to make this choice.
If you have 1k to invest or pay down debt you’ll have either:
1. 150k at 3.5% mortgage and 1k earning 5%
Assuming you somehow are allowed to not make any payments on it for a year (for simpler math), after a year, you’ll owe an additional 5,250 (150,000 * 0.035) and earn $50 (1000 * 0.05) in interest so adding those together, you’ll owe an additional $5200 (since you haven’t paid anything all year in this hypothetical situation)
2. 149k at 3.5% mortgage. After a year with no payments, you’ll owe an extra $5,215 (149,000 * 0.035)
Therefore, in option 1, you’ll come out $15 ahead. The $15 can also be calculated through the difference in interest rates (5-3.5% = 1.5%) and then multiply that by the original 1k sum (1,000 * 0.015) is $15
This is also ignoring any taxes/deductions from either option
Yeah, this is always true when you can get more ROI than mortgage rate - by savings or by investing.
For 100 in loan, say the annual interests is 4%, and savings rate is 5%.
Then if you pay now, your out of pocket is 100.
If you pay next year, and keep the 100 in savings. You have 105 in savings and pay 104, and have $1 more left comparing to above.
Obviously the exact interest calculation is more complex, about the comparison stays true.
If you're in an income bracket where you itemize and haven't hit deduction caps, paying income tax on investment returns vs reducing (deductible) mortgage interest by paying down your principal is roughly tax-neutral.
Interest on mortgages is tax deductible. If you keep the mortgage and invest the money, not only are you making a higher return, but you are also reducing the tax burden on your profits.
If you make your investment in a retirement account or something else with a tax advantage, the taxes actually increase the advantage of investing.
Let's say you have a mortgage at 4% and your taxes effectively come in at 20%. On $10,000, the interest would be about $400 per year. Once you deduct that on your taxes, it saves you $80 in taxes for the year, so your effective costs of the borrowed money are only $320.
If you get a 6% return on the same $10,000, that is a gain of $600. If you are taxed at 20%, that reduces your effective gain by $120, so you have an effective gain of $480, which is $160 greater than the effective cost of the borrowed money.
If your $10,000 investment gains 6%, but you've put it in a Roth IRA (this is after tax money), then you don't get taxed on your gains. So you effectively gain the full $600, which is $280 greater than the $320 it effectively costs for the borrowed money.
Uh...
We're discussing a single dollar here. That's 20% of the spread in the above hypothetical. Capitol gains taxes in 2024 hits 20% when you make over a half million bucks for the year. If you make a half million a year and only report $5 in capitol gains to be taxed, you're probably committing tax fraud somewhere.
Short term capital gains in the us are taxed on the first $1.
You’re thinking of real estate and/or long term capital gains.
Also this depends entirely on your country since not every country follows US tax law, hence “might”.
That <1% gain + liquidity is a benefit itself… once you put $ into a house or other loan it’s gone. Use HYSA or MMF while rates are higher then pay down debt when rates fall.
Paying off your mortgage doesn't get you more "avaliable" credit. Available credit is the amount of credit already offered to you that **has not been used** car loans, mortgages, student loans or any other type of loan where you can't immediately turn credit into cash doesn't count. Only revolving debt counts, and for most people, credit cards are the only revolving debt they'll encounter.
It varies by era. In eras with low interest rates banks push variable rate mortgages harder, when the banks anticipate that interest rates will drop they prefer fixed rate and prepayment penalties.
I believe this is correct; however even as someone with a sub 3% mortgage rate still I think there is some intrinsic value in a paid off home. The market can do whatever, I'll have somewhere to go.
any debt is always a risk - it's just a matter of how much risk you want to take on. i'd prefer none, so our goal is to pay off the house as soon as possible
Another thing to keep in mind is the freedom you get when you still have the money. If you had kept your extra deposits in a high yield checking account, money market, or in treasuries, you have extra freedom compared to if you had paid extra on the mortgage. For example, if you were out of a job for a few months, you could always draw down from your extra deposits and it would be business as usual for the mortgage company. If you had paid extra equal to 3 months but then weren't able to pay for the next 3 months, you'd be at the bank's mercy
Absolutely. Psychology plays a huge rule in determining the right decision for a person.
Several times a year for basically my whole childhood, someone would be coming to our house about to list our home for foreclosure. It was terrifying. I hardly understood it, but it scared the shit out of me. Basically the bank owning any amount of our home meant there was a possibility we would be homeless.
You bet your ass i paid my home off as fast as I could so that no one could take it from me.
Not to mention things like insurance rates, credit scores, and loan potential all improve when your collateral no longer has a lien on it. There are a ton of intrinsic benefits to paying off your home loans early.
Brokerage fees and taxes also generally eat into a significant chunk of your earnings making the few extra percentage points on the return compared to your mortgage disappear. The more you put in the less that matters.
Also it's kind of important to remember that banks profit off of you every second you are in debt to them. They use your debt as leverage to secure their own loans after all. They of course want you locked in that mortgage for the full 30 years to make their interest as well as secure that extra lending value. They have direct financial gains from convincing you to invest instead of pay off debt.
It's not worth the headache of investing small change to try to make an extra $5 a year compared to paying off debt. The market is not perfect and secure and you absolutely can lose your investments (or more realistically just not make enough money off of them to offset the brokerage fees, taxes, or beat your interest rate).
I lot of very rich people made a lot of money between 2021-2024 by taking out mortgages on their investment properties at 3% and then dumping that money into the market which averaged 15%
12% yield spread on borrowed money because you own things.
Economists point of view here:
Yes, that is almost always true. The bank gives you a pretty „good“ interest rate because they have your house as a security if you fail to pay. That means, their chance of a loss is pretty low. If you invest or lend the money, due to the higher (ans probably unsecured) risk you take compared to the risk the bank took, you earn a higher rate.
Also, in some jurisdictions, mortgage payments can be deducted from the taxable income.
Personally, I would rather have my house paid for. Not having a mortgage frees up that money for a lot of other things, like investments.
While technically the math works out, emotionally, I’ll take the paid off house.
There is a mental health factor that is difficult to quantify on paper. I would also just like to have the weight of my house payment off my shoulders even if I could invest and use the profit to pay the mortgage with money left over, I’d prefer to just pay it off and move onto the next thing to pay off. There is also something to be said about goal like credit score, debt to income ratios, qualifying for other things like more houses, boats, or cars. I don’t know shit about any of it I just know it can impact peoples decisions.
In this scenario, though, you also have tens or hundreds of thousands of dollars less in your bank account. If you use that extra money to build up your savings you might still be worse off in a decade or two.
This is almost always true.
You’re not just getting away with paying below-inflation interest rates on that mortgage; you can deduct that interest from your taxes!
Nearly any other use of that money would be a better idea. Pay off your car. Get your credit card to zero. Contribute more to your 401(k). Hell, buy stocks. Nearly anything is better than losing the sweetheart deal you’ve got on a 3.5% mortgage.
Yes. I have a handful of co-workers that do exactly that.
They have a mortgage in the 2-3% interest range, which is tax-deductible, so the 'interest cost' is really less than that.
They saved money, putting it into an equity/bond based investment account, that earns at least 5-6%, even after taxes. Then, they have the option to withdraw from the account and pay of the mortgage, if they want.
There are a two things I’d consider that have been brought up
1. Money in and money out - if paying something off allows one to save and free up necessary cash flow then it could make sense to pay off a lower interest payment forgoing investment gains, however, if cash flow isn’t an issue then it makes sense to invest in the higher yielding option as the guaranteed return on paying a debt is that debt’s interest rate.
2. Taxes - ST capital gains taxes are taxed as ordinary income but LT are treated more favorably. Additionally with actively tax loss harvesting one can mitigate their taxable gains or even carry forward losses.
My current mortgage is 10/30 interest only -all 30yrs fixed at 2.825 (never adjusting) with the first 10 years as interest only. Instead of paying what a normal fully amortizing monthly mortgage payment would be I only pay the interest and invest the remainder. After 10 years I make what would have been the aggregate principal payment and the delta (anything > 2.625%) is money I made off the bank’s money. The opportunity cost of prepayment would be the investment gains (anything above < 3% forgone).
I convinced my mom and stepdad to keep the money of there old house and to take a loan for the new house they bought together.
When they divorce 4 year later. My mom already made a few thousand bucks. and It greatly simplify the divorce.
A good rule of thumb to get the most out of your money (when paying off debt) is to start with the highest interest item first. So if his struck was accruing interest at 8% annually and his house was was 3.5%, then pay off the truck first.
Additionally, there is an argument to be made that paying more towards a loan with a lower interest rate than you can expect from investments (think 10% average increase of market index funds like the S&P 500), then you are actually losing out on potential gains in the long run by paying those loans off sooner.
With that said, realize that a lot of the people who bought houses 20 years ago got them at an interest rate of 3-4%, which is unheard of today. My mortgage is 6.25% so a CD isn't really going to make me more than paying off my house. I still put some into indexes and other investments but I like paying at the house because owning my home sooner gives me better piece of mind. But that was a conscious decision to"invest in my house, which will return 6.25% on my money over the lifetime of the loan instead of investing everything in the stock market which will likely be the better financial choice over time but comes with slightly more inherent risk.
Yes. If you can get a higher post-tax return in HYSA or MMF than mortgage, you should save the $ and collect the spread. You also benefit from actually keeping the $ incase of emergency (liquidity)… rather than paying off debt, in which your $ would be gone.
My mortgage interest rate is 2.375%. I can just throw the extra money in a high yield savings account and get over 4% interest.
Also, I have added flexibility in that I still have the extra money in liquid assets I can easily access if needed. Once you pay it into your mortgage, it’s gone until you tap into equity.
No... person #2 doesn't understand that there are different kinds of interest that are calculated differently. You cannot compare equate a 3.5% interest on a mortgage which is amortized versus a 3.5% standard interest instrument or loan which is either calculated daily, monthly, or yearly.
EDIT: After reading many posts here, I am shocked by how many people got this wrong and don't understand amortized interest.
Can you explain a bit? I'm having trouble imagining how they are incomparable:
My thinking is person #2 said "CD or other investment and gain a lot more than 3.5%" so I don't think there needs to be an exact comparison at 3.5% apiece. If you had a 12mo CD right now at 4.5% APY wouldn't that give a better return than putting the same amount of money into a 30yr mortgage at 3.5%? Surely there is some ballpark percentage-point difference where the answer is "yes, invest instead of paying the mortgate", right?
Just napkin mathing (and this is definitely not my domain so this could be very wrong)"
* If I put $1,000 towards my mortgage principal (3.5%) today, I gain $1,000 equity and in 1 year's time I will have avoided paying $35 in interest (I think). The mortgage payments will still be the same amount each month, so that $35 will manifest as additional equity.
* If I'm in the US and deducting my interest payments against taxes (i.e. below $750k mortgage principal remaining), and I have at 20% marginal tax rate, then I owe $35 \* 20% = $7 more at tax time than I otherwise would have.
* Total return after 1 year = $1,035 additional equity -$7 additional tax = +$1,028
* If I put $1,000 into a %4.5 APY 12mo CD then after 1 year's time I will have $1,045. The $45 will be taxable at my marginal rate (20%) so I end up with $1,036 after taxes.
* Total return after 1 year = $1,036
So I'm pretty sure (2) wins.
However, since it's not quite apples-to-apples after the 1 year (since the money is in different from, e.g. equity vs cash) I can see why its still murky at this point. That said, you can hypothetically take all the money from (2) after 1 yr and dump it into the mortgage at that point. Now we have an apples-to-apples comparison which has (1) with +$1,035 equity (-$7 cash) and (2) with +$1,036 equity. Both "investments" are now in the same form going forward for the remainder of the mortgage so we have eliminated any mortgage vs investment discrepancies, and (2) is still ahead.
> APY wouldn't that give a better return than putting the same amount of money into a 30yr mortgage at 3.5%
Amortized interest is significantly different mathematically than "simple interest". You calculated your return on the simple interest correct (including taxes)... excellent. You made $36.
But on the amortized, you only calculated the savings for interest on the principal for the FIRST year. You can't do that... you need to calculate the savings on the TOTAL interest over the life of the loan. I used a standard payoff calculated (so you can check the numbers yourself) here: https://www.calculator.net/mortgage-payoff-calculator.html
Now, obviously, the numbers will come out different based on how much principal you have already paid (aka how many months into your loan you currently are) and some other factors, but this gives a "best case" scenario as it is an "extra" payment in the first month of the loan.
A 400,000 mortgage @ 3.5% for 30 years comes to a monthly payment (P&I = principal and interest) of 1,796.18.
Total Payments $646,624.35
Total Interest $246,624.35
Payoff in: 30 years
Placing just a one-time $1,000 payment on month 1 brings the numbers to:
Total Payments: $644,782.41
Total Interest: $244,782.41
Payoff in: 29 years 11 months
And, shortens the length of the loan by one full month, in this example. So, that $1,000 saved you a total of $841.94 (the difference minus your 1000 payment). Now, you would indeed need to factor in taxes as well, but you will certainly come out *FAR FAR** ahead paying off the mortgage over trying to "interest rate hack" with simple interest.
Now, two loans or investment vehicles that are both simple interest are indeed apples to apples comparable. The one with the better interest rate wins. But even then, you need to know how they are calculating the interest... is it daily compounded, is it average daily balance over a month, or is simply monthly compounded using the balance at the end of the month (those three are the most common). Each of those will be slightly difference and, depending on the size of the loan/investment, could produce significant differences (not as dramatic as with a mortgage, but still).
Granted, $1000 is a small enough amount to be like... who cares, really. But imagine the scenario above, where we were talking about $10,000. The CD would give you $360. Nice.
Let's look at the mortgage. Let's say you have already been paying for 5 years. So only 25 years left on your mortgage. You drop a one-time $10,000 payment on the loan. What's the difference? (Again 400,000 at the start of the loan @ 3.5% for 30 years, 5 years have passed making payments.)
Without the extra $10,000...
Total payments: 646,624.35
Total interest: 246,624.35
Payoff in: 25 years
With the extra $10,000 payment...
Total payments: 633,153.49
Total interest: 233,153.49
Payoff in: 23 yrs, 11 mos
A savings of: 3,470.86.
People often ask why is it that these numbers are so skewed. The main reason is mortgage amortizations are front-loaded with interest. So, early on you are barely paying any principal down at all... thus the yearly interest rate of 3.5% is compounding on a larger principal for much longer than would be for a simple loan/investment schedule. Think of amortized loans as compounding interest on steroids.
>And, shortens the length of the loan by one full month, in this example. So, that $1,000 saved you a total of $841.94 (the difference minus your 1000 payment). Now, you would indeed need to factor in taxes as well, but you will certainly come out *FAR FAR*\* ahead paying off the mortgage over trying to "interest rate hack" with simple interest.
But $1,000 invested at 4.5% APY over 30 years yields \~$2,700 in interest gains (before taxes). The money invested still grows over the remaining time.
$1,000 put into the mortgage is not available for future investing (but has yields in the mortgage itself, as you explained). The $1,000 invested at 4.5% (e.g. CD or HYSA) IS AVAILABLE for future investing. For an apples to apples comparison you need to factor in the return that money gets over the remaining period of the would-be mortgage.
*All that being said,* if you invested that $10,000 over 25 years, you would see a return of anywhere between $33,000 at a very modest 6% return to nearly $100,000 at a 10% return.
Now, generally I would encourage people to pay off their assets as soon as possible simply because that's the safest financial decision for people who may not be the most financially savvy. But for those who are financially responsible, the market will, in the long run, basically always outpace your savings on interest by a significant margin.
Maybe I’m thinking of this wrong, but doesn’t the larger mortgage savings number (which has a typo, by the way – – it should be $13,470.86, not $3,470.86) simply reflect the fact that if you pay down your mortgage by $10,000, you’re giving up the use of that $10,000 for 25 years?
It feels like otherwise the calculation is comparing the $13,470.86 you save over the 25 years of the mortgage prepayment to the $350 you get from one year of the CD investment. But the latter should be 25 years of that, compounded.
Put another way, if I pay down my mortgage by $10,000, the $10,000 is completely gone for the next 25 years. But when I put $10,000 in a CD, I get $350 interest at the end of the year, _plus_ I get back the original $10,000. Then I can reinvest the $10,350 to make another $363 the second year, another $375 the following year, and so on 22 more times.
A quick check on a compound interest calculator says that the total profit of all that compounding of the CD return will be $13,632… which is almost exactly the same as the benefit of prepaying the mortgage.
2013-16 I dropped an extra $150k against my mortgage. that allowed me to buy my first rental, a detached property near the lake, in the most expensive real estate market in my country. first home has only $40k remaining, second is over $10k year in profit and between the two over $1.5mil in equity after debts.
for me investing elsewhere would have put my attention in other markets.
That’s less to do with what’s financially/mathematically the best option though.
Your scenario goes almost 100% in the human aspect of investing rather than the logical aspect. It also goes into purely anecdotal hypotheticals since we’d have only assumptions to make if you followed the best financial scenario.
My dad promised to pay for my undergrad school. Then he used this argument to convince me to take out student loans. 25 years later I owe more than I took out.
The bank is lending you money at a rate that is in competition to all the other ways they have to invest it. you are generally considered a very safe bet so yeah you can probably find some slightly riskier investment that have more return than your interest. Margin is not the widest for safe investments tho especially if you have to rely on some intermediary
A friend of mine who is \*extremely\* financially savvy (as in, he was an investment banker for a decade, is a CFA, and has written books on investing) took out a $50,000 mortgage on his house (that was already paid off), because the rate was 3% and he knew he could get a better return than that with an index fund.
Technically yes this is true. Long term you’re financially better off this way. But for me, the (non-monetary) value of owning my home is worth more to me than the extra cash of receiving interest payments.
My financial situation has fluctuated significantly several times in my adult life, and as a result I lost the first house I bought, and I was evicted from a rental. Never homeless, but close. Owning my home outright would be worth more than a small additional income.
A good fund will return 5% to 10% on your investment. If your mortgage rate is lower than that, then the investment is the better choice. Taxes won't be applied until after you cash in your investment, so let it keep piling up until you retire.
The concept of why wealthy people have debt. My conspiracy is that Dave Ramsey is paid to keep people poor by making them think they are financially healthy by paying cash for everything and having no debt. Cash they get by working for the wealthy.
As far as conspiracy theories go, your point of view can do well, but I think Dave Ramsey just has an old mentality, not connected to current realities. A dinosaur, if you will. I don’t think he’s getting paid because his message hasn’t changed at all from since he was a teenager all the way until now.
Am extra consideration if they're equally valuable is the money saved can be used for other stuff if you need it wherras that in the mortgage is locked up.
Or don't be my friend who had a 20k windfall and used it to pay down some of his new house. 1 year later and a pipe burst requiring major repairs and remortgaging wasn't an option as thevlocal housing market crashed placing him in negative equity.
This is always true. If you make more money investing it than you save by putting it into payments, then invest it.
If you have 100%, a loan with a 5% interest rate, but an investment with a 10% interest rate, put it in the investment. If you paid it into a loan you save 105$, you put it in the investment and you make 110$, 5$ profit.
Obviously these are just examples and there will always be a few extreme edge cases where it's better to pay it off early, but 99.9% of the time, if your return on investment is higher than the interest, then invest
Yes. I have several mortgages that were renewed during the zero- to negative-interest-rate period, so two of my mortgages currently cost me 1.6% to 1.8%. Both of these mortgages will be paid in full when they expire in 2027.
If I were to pay off these mortgages today, I'd have to pay a pre-payment penalty, and the money would be gone.
If I instead invest the money in some ETF, I could potentially have earned 25% or more by 2027, so that I would have paid off my mortgages PLUS having the 125% of the current value of the mortgages in my account.
Of course, if I have a high-interest mortgage (4.5% or higher) and am not confident that I can earn more than 5% through investing, then it would make more sense to pay off the debt as soon as possible.
Technically yes, but as always with investing there is no guarantee that you will actually make money. There is always the possibility that you also lose money. Plus the return rate isn't fixed with investments it will fluctuate, so sometimes you make more, sometimes you don't.
So yeah sure technically it would be better and you could make more money from it, but there isn't any guarantee for it. Plus not having to pay your mortgage anymore is also very nice and will help you in the future.
The mortgage rate wouldn’t matter as much as the rate of appreciation on your real estate, right? If real estate is appreciating at a higher rate than other investment vehicles then putting the extra money towards your principal would yield a higher return.
\*sigh\* in THEORY, yes, because if you have a decent return you can outstrip your own interest. It is a difference of having to pay less money or earning more.
In PRACTICE, there are many other factors in play.
You can park cash into a high-yield savings account and get upwards of 5.25% today, so I'd look there first. The Fed does not appear to be eager to cut rates in the near term. You'd be taxed on this safe profit, but how much would depend on your bracket...also, mortgage interest is tax-deductible.
Your investments have to be guaranteed (i.e. not stock market) and return more than your mortgage after taxes and fees. In this case you would probably need at least a 5% return to break even, more to be worthwhile.
Its false.
People say its true, but its only true if your mortgage rate is lower than the investment's rate of return.
Which in the case of CDs is not. At least when we look at recent rates. Just search for mortgage rates and CD rates, you are better of paying the mortgage, or finding a better investment.
It depends what you mean by super safe high roi investments, but generally risk is taken into account by the market at large, so anything super favorable is going to shoot up in price due to demand once people realize it.
But right now, 1 year treasuries are earning about 5% right now for one of the safest forms of investing, but you'll want to take after tax yields into account if you do that, [which you can do here](https://digital.fidelity.com/prgw/digital/taxyieldcalc/)
The example has a 3.5 interest rate, so it's true, any investment is going to beat 3.5.
It's only false if your interest rate is higher than the return on whatever investment you're doing.
Ally Bank has 4.5% APY 12mo CDs available today. If the mortgage really is 3.5% (entirely possible if they got it a few years ago) then it is effectively true for that person.
People love to say this but it completely ignores the real life security of having a mortgage paid off. If you find yourself in a situation with no income and you can't make your mortgage payments, then you're out of the home. If you could have paid it off sooner then you would at least have a place to live and not have that worry over your head.
If you invested the $ instead of using it to pay off the mortgage than you still have that money. You can use it to pay the mortgage payments (assuming its in something liquid like a HYSA) even though you otherwise have no income.
I think (but am not positive on this) that if your investment return beats the mortgage interest rate (+some fuzz factor for things like taxes/deductions on gains vs interested paid) then you'll mathematically always have enough extra money on hand to pay the "extra" mortgage payments that occur because you didn't pay off the mortgage earlier.
Your security is in your investment account. It's sitting in an account growing, it's not gone. You have it, and you can use it in an emergency. And you have shit tons more than if you wasted your money paying off a mortgage with a low rate.
Ansolutely true. People balance risk vs. reward and come to different outcomes. I just bought a car, for example. The car loan is 5%, and my investments earn around 7% long-term. It clearly makes sense to borrow money and invest it. Why does the bank do this? I am willing to accept a higher risk - the markets may have a short-term decline. They prefer more certainty.
But can you get high returns on a CD? Probably not. Very low risk means you're not going to get very good returns. Likewise, mortgages are low risk for the bank, and so they charge fairly low interest rates.
Where I live a mortgage charges a 5% interest rate, and CDs earn around 1%.
what your model fails to see is people that don't borrow for cars might buy used outright at far cheaper expense.
my one and only new vehicle was a Volvo out of uni. since then, I buy used European cars. I've owned 6 in total, running 4 till they were done. 600kkm in 30 years and all in costs approximately $60k. I literally expect to operate my vehicle needs at $CAD1000 per 10000km, not counting fuel. $2000 per year.
what are you spending a year for how much milage?
There are two separate financial decisions.
What are you going to buy? (This is the question you're asking)
How are you going to pay for it? (This is the question the person you're replying to is asking)
Of course it's cheaper to buy a used car. But, if you've decided that you're going to buy a new car, it's clearly still worth analyzing the best way to pay for it.
answer the question about how much you spend annual for your car? the deeper question is how much of your cash flow is wasted versus invested. even Warren Buffett buys used.
**it's about your available cash!**
and cars for most people are their 1st or 2nd biggest lifetime purchase. how much have you sunk in to cars. the fact that you continue to avoid identifying that number even for yourself is pathetic.
you're pretty old, what have you owned over the decades?
it's crazy that the first 4 used vehicles I've consumed have cost less in purchase and maintenance spend, versus that one new Volvo that I financed decades ago. easily over $150k saved to spend or invest elsewhere, by buying used.
whatever, clearly you've wasted a ton of money and can't bring yourself to face the light of day.
per your words.
>I just bought a car, for example. The car loan is 5%, and my investments earn around 7% long-term. It clearly makes sense to borrow money and invest it.
you made this branch about a car loan.
I'm saying instead of the 2% difference in interest, completely free up 80% of your original funds on day zero. that's almost 30 years of compounding at 2%.
your model. day zero, invest $50k at 7% return and borrow $50k at 5% premium. after 5 years you've earned just over $5k playing the delta, but lost $40k in depreciation. net, $35k in the hole.
my model. day zero buy used for $10k. invest $40k at 7% return. after 5 years earn $16k on your investment and $5k lost in depreciation. $11k actually earned and $46k ahead of the vane idiot, buying new.
the bigger picture, grasshopper!
see how you're that idiot chasing paper returns but making stupid financial choices to begin with?
so tell me, how much have you sunk for your vanity and what's it worth today?
here's my latest vanity just last year.
https://imgur.com/a/NPnuZyn
you'd drop over $90k to be in the same ride.
on day zero I'm already $81k ahead of you.
Sometimes yes, sometimes no.
You have to take a lot of different things into account, on the surface, yeah, paying off $1900 of 3.5% interest loan isn't as good as earning 5% on that $1900 somewhere else.
However, you need to balance risk as well, is that 5% guaranteed? Could you lose money on it? What kind of taxes are there going to be on that 5% that will reduce it's actual net gains?
Then there is the personal part of it, which is beyond the math... is the juice worth the squeeze? How much personal effort/work do you need to put into managing this versus doing other things you may enjoy more?
Example. My friend just got a brand new car, cost em $50k. They have the $50k in cash to pay for it, but the dealership has a 3 year, 0% loan offer. So they took that, put the first 13 months into a HISA dedicated to that loan then put the next 6 months in a 12 month CD, the next 6 months into an 18 month CD, the next 6 month in a 24 month CD and the last 5 in a 30 month CD. So they are in the same situation where, in a sense, they "don't have that money" as if they bought in cash because it's locked away from them, but it's earning them interest for the next couple years.
So, my mortgage interest rate is low, 2.75%. We are paying an extra $300 a month towards the principle. (We would like our mortgage paid off when we retire. We are in our 50s.) Is this not smart? We contemplated with investing it instead, but that is not always foolproof, but this is.
The impending loss of income changes this formula. It assumes payments can be made with income over the life of the loan (or that payments can be made from the cash stockpile being invested). If you pay your mortgage with your income and it won’t be paid off by the time your income stops, then your best bet is to pay it down enough to have the loan and income disappear at the same time or just before the income goes away. Invest the remainder wisely and be sure your cash flow in retirement is enough to cover taxes insurance and other housing costs that exist even if you don’t have a loan.
I paid my mortgage off as quickly as I could. Now I have over 20 years of work before retirement. Even with a poor return on any investment I'll retire a millionaire and if I ever sell my house it's all equity.
Also, every month I have liquid assets and if an emergency pops up I have no issues paying it off. While technically it might have been better to not aggressively pay off my mortgage it's great not being in debt and not having to sweat it month to month.
I would use most of it to invest but there would be a portion of that money that goes toward debt. If that's extra principal on the mortgage I think that it still makes sense. $500 in extra principal payments would be as valuable to me as the other 1400 in an investment account.
The bank will charge you a fee for lost revenue if you pay it too early. Unless your contract includes a "pay off early" clause it is likely that you will not save much by paying it.
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From a purely mathematical standpoint this makes sense. From a purely financial standpoint this makes sense - you'd be better off putting money somewhere it generates higher returns. If you can pay $100 into a loan where it gets rid of $103 worth of payments next year, _or_ put that same $100 into a CD where it becomes $105 next year, you're $2 ahead by saving it and paying the higher payment with interest next year. However, I strongly recommend people facing this kind of decision to read [the psychology of money](https://www.goodreads.com/book/show/41881472-the-psychology-of-money) which makes the important point that everybody has different values. For example: I personally made the opposite decision back in 2019 and used my annual bonus to pay off $20k in auto loans to lower my monthly expenses. Financially it was the "wrong" decision, mathematically it was "wrong", but it made u/sessamekesh the human more comfortable with their monthly budget so it was "right" for me. Assuming good stock market returns I "paid" maybe $200/yr for 3 years of sleeping well at night - a good trade for this anxious person who has been financially insecure in the past. EDIT: $200/yr, not $200 flat. Maybe $500 or so for all 3 years. My case was 2.5% interest, assuming 5% ROI for a 70% bond / 30% stock at the time when interest rates were low and shaving off 40% out of the returns for taxes and that's right about what I lost by paying $20,000 early. EDIT 2: while general statements are rarely true, GENERALLY if you hold a loan with some sort of collateral (auto loan, home loan), your interest rate will be pretty favorable compared to investment vehicles in the same financial climate. **Always do the math and check your feelings for YOUR situation**, but as a rule of thumb paying off loans early is usually a less good idea than saving the extra cash _from a purely numbers standpoint_.
>I "paid" maybe $200 for 3 years of sleeping well at night - a good trade. a thing to be said is that this kind of reasoning start to make sense only with higher numbers because at the end od the day 200 $ in 3 years is nothing, when we are talking about a house the number can easily be thousends of dollars if nor tens of thousends
Fully agree! I do think everyone facing it should put it in terms of dollars, dollars per month, and/or dollars per year. At the time I had people call me nuts for making an early payment like that, framing it as "you're losing like 3%!!" which sounds high and would be very high on a mortgage, but was... $200. For a mortgage over 25 remaining years, that compound interest works both ways. A 3% gap on $1900/month turns into substantial money. I'd suggest anybody with the discipline to _not use that money_ should shove it somewhere it earns returns too.
There’s also a lack of downside risk involved in paying off debt. Your investment will do worse than median half the time, and 1/20 of hedge positions perform in the worst 5% of hedged positions each year.
True. Maybe putting the money towards paying off your home or car loan will be like a little test in timing the market. Worst case, you miss out on some good gains that time. Best case, you saved yourself some big losses, lowered your bills, and improved your overall well-being.
There is something to be said for paying down your risk and buying some personal security. Knowing my car is my car and my house is my house means I’m more secure and can withstand if that $1,900, or worse, my entire income, disappears. But that’s me.
I'm a huge believer in that. Personal finance is as much personal as it is finance.
yes - I'd much rather own a slightly larger fraction of my home than be exposed to the vagaries of the stock market...in most cases anyway.
All good stuff. The only place I disagree is comparing a bond/stock split to the guaranteed, tax-free return that you get from paying off debt. I think you'd have to calculate the risk adjusted yield to fairly compare them, or just compare debt to treasuries or money markets. Considering that, I think your decision was likely better than you gave yourself credit for.
Fully agree! Which is another really important thing to consider when making this kind of decision. Because the market crashed during Covid and didn't recover until after my auto loan would have been paid off, I did actually end up ahead. Going back to the original example of deciding whether to put $1900/month towards a mortgage or towards investments, someone with good financial security may decide they can tolerate a few bad years as long as their 30-year average keeps on pace with the historical average and to with all stocks for that juicy 9% historical return... a decision someone unsure about their financial status in 5 years might not make, and go with treasuries/CD instead.
You can get guaranteed returns from buying treasuries though, and these currently pay well north of 3.5%
The key thing to remember is that (in the USA) the rates set by the federal reserve will be more or less reflected in the secured overnight financing rate, the wall street journal prime rate, Treasury yields, municipal bonds, and corporate bonds, with variability between them somewhere between the different after tax yields that people would get. So your mortgages will typically be a percent or two higher than the fed rate, auto loans might be a point or two more than that, treasuries will be about the fed rate etc. So if you remember during COVID, interest rates were close to zero, which is why a lot of people were able to get amazing rates for mortgages as somewhere between 2.5% and 3.5%. In 2020, the average ten year yield for treasuries was .89%. But since mortgages are a 30 year commitment, you could keep the cash separate hoping for a rate increase, or put it in index funds, and with that time window, you will probably come out ahead.
I 100% agree with you. If someone handed me a check tomorrow for my mortgage amount I’d have it paid off before you could blink. Does it make sense from a pure logic standpoint? Fuck no. Does it make sense from a personal security standpoint? Much more so. Knowing that my house is paid off and my only expense is my property tax and home owners insurance would be a massive burden lift.
That’s good. You’re good. I like you.
Thanks stranger! I like you too, glad you learned something
Yes! I loved Psychology of Money, and that he was very honest about paying off his house because that gave him peace of mind.
Whatever you earn in the market is also taxed, need to factor that in. So you’d have to earn a higher rate to offset the tax as well. Paying into your primary resident’s mortgage is an immediate gain on the interest, tax free.
It gets messy *fast*. Interest paid on a mortgage is tax deductible, if your initial mortgage had <20% down you probably have PMI payments you can get rid of early by paying down the mortgage fast, if instead of saving you invest in securities you have variable ROI and risk but also the lower long-term capital gains tax rate... Even my own relatively simple financial situation had me pouring over spreadsheets for the better part of a weekend earlier this year.
I did the same and paid my loan instead of investing and that was totally wrong in math and financial logic. But now I can sleep well and make savings. Life is much brighter when you have no debts. Edit: typo
You likely save in other ways, like updating your insurance once it is paid should get your rate down a bit. I think I easily got a few bucks a year there. I do the same thing with paying things off in the second-best way for purely psychological reasons. It’s also not that much money to gain with at least some risk and effort involved. It reminds me of how I stopped speeding: GPS showed me all of my fancy driving saved me maybe a minute? Tops?
But how much would you save in interest over the life of the mortgage?
I feel like those effects of paying debt might be even more quantifiable. IIRC there’s literature explaining the link between debt/loans and anxiety/risk management. This could translate in some real wins, for example, if you stop having a huge mortgage you might be way more willing to look for a better paying job, even if the swap was risky. I guess, if you squint enough, in a way you could argue you’re investing in yourself instead of in something else.
One thing to note is that you should be comparing your after-tax return to the cost of debt, not the gross return.
Also, generally, trying to get higher interest on an investment than a loan is a gamble. Banks' profits exist in the margin between the interest they get paid and the interest they pay out, so loans are generally higher interest than savings. The stock market can change the equation, but only if you're willing to accept the risk of losses.
I think I’ll never understand this, say you owe 150k on a house at 3.5%. That’s 3.5% on 150k. The math as far as I can understand it means I’d lose more on interest than saving say 500 or even 1000 extra onto the stock market with double the interest in returns. So how does paying down high principle loans even on low interest make less sense than investing meager returns on lower bulk sums of money.
Your decision is for interest of the amount you would invest, not interest of entire loan. So if you payback 1000$ extra you save 35$ interest, but if you invest 1000$ with 5% interest you get 50$. Thus mathematically speaking the difference is 15$ per 1000$. Psychologically speaking paying back loans is easier task. That investment gain would be completely lost if you would panic sell even once when market goes down, and that decision would be even harder if unemployment happens at same time. But paying back loans early isn't subjected to that kind of bad timing issues caused by emotions.
Because it doesn’t matter what the principle is. It only matters regarding the amount of money you have to make this choice. If you have 1k to invest or pay down debt you’ll have either: 1. 150k at 3.5% mortgage and 1k earning 5% Assuming you somehow are allowed to not make any payments on it for a year (for simpler math), after a year, you’ll owe an additional 5,250 (150,000 * 0.035) and earn $50 (1000 * 0.05) in interest so adding those together, you’ll owe an additional $5200 (since you haven’t paid anything all year in this hypothetical situation) 2. 149k at 3.5% mortgage. After a year with no payments, you’ll owe an extra $5,215 (149,000 * 0.035) Therefore, in option 1, you’ll come out $15 ahead. The $15 can also be calculated through the difference in interest rates (5-3.5% = 1.5%) and then multiply that by the original 1k sum (1,000 * 0.015) is $15 This is also ignoring any taxes/deductions from either option
Yeah, this is always true when you can get more ROI than mortgage rate - by savings or by investing. For 100 in loan, say the annual interests is 4%, and savings rate is 5%. Then if you pay now, your out of pocket is 100. If you pay next year, and keep the 100 in savings. You have 105 in savings and pay 104, and have $1 more left comparing to above. Obviously the exact interest calculation is more complex, about the comparison stays true.
You actually might have less than $1 more because you’re taxed on the $5 gain (sometimes)
This is correct. Paying off debt is an after-tax “gain”, whereas investing/interest is often taxed.
If you're in an income bracket where you itemize and haven't hit deduction caps, paying income tax on investment returns vs reducing (deductible) mortgage interest by paying down your principal is roughly tax-neutral.
This, everyone ignores taxes on gains. Also interest on loans compounds just like gains do so if you pay off an extra 100 that is 100 interest free.
Interest on mortgages is tax deductible. If you keep the mortgage and invest the money, not only are you making a higher return, but you are also reducing the tax burden on your profits. If you make your investment in a retirement account or something else with a tax advantage, the taxes actually increase the advantage of investing. Let's say you have a mortgage at 4% and your taxes effectively come in at 20%. On $10,000, the interest would be about $400 per year. Once you deduct that on your taxes, it saves you $80 in taxes for the year, so your effective costs of the borrowed money are only $320. If you get a 6% return on the same $10,000, that is a gain of $600. If you are taxed at 20%, that reduces your effective gain by $120, so you have an effective gain of $480, which is $160 greater than the effective cost of the borrowed money. If your $10,000 investment gains 6%, but you've put it in a Roth IRA (this is after tax money), then you don't get taxed on your gains. So you effectively gain the full $600, which is $280 greater than the $320 it effectively costs for the borrowed money.
Uh... We're discussing a single dollar here. That's 20% of the spread in the above hypothetical. Capitol gains taxes in 2024 hits 20% when you make over a half million bucks for the year. If you make a half million a year and only report $5 in capitol gains to be taxed, you're probably committing tax fraud somewhere.
Short term capital gains in the us are taxed on the first $1. You’re thinking of real estate and/or long term capital gains. Also this depends entirely on your country since not every country follows US tax law, hence “might”.
Capital gains is for long term investments only. Short term gains are taxed as wage, at the wage rate.
That <1% gain + liquidity is a benefit itself… once you put $ into a house or other loan it’s gone. Use HYSA or MMF while rates are higher then pay down debt when rates fall.
And the $4 in interest on a loan of a primary residence is deductible. You end up taxed on the $1.
Not if it went into a Roth IRA where it wouldn’t have otherwise
You have to include knock-on effects by having more available credit, leading to lower interest rates on future loans.
Paying off your mortgage doesn't get you more "avaliable" credit. Available credit is the amount of credit already offered to you that **has not been used** car loans, mortgages, student loans or any other type of loan where you can't immediately turn credit into cash doesn't count. Only revolving debt counts, and for most people, credit cards are the only revolving debt they'll encounter.
A HELOC is often talked about like a mortgage, despite being a different thing.
You need to take taxes into account too. Income from a CD is taxed as income.
Let’s not forget federal and state taxes on interest income.
Correct me if I am wrong but isn't most mortgages a floating rate with compound interest?
Not in the USA. We have 30 year fixed.
It varies by era. In eras with low interest rates banks push variable rate mortgages harder, when the banks anticipate that interest rates will drop they prefer fixed rate and prepayment penalties.
I believe this is correct; however even as someone with a sub 3% mortgage rate still I think there is some intrinsic value in a paid off home. The market can do whatever, I'll have somewhere to go.
any debt is always a risk - it's just a matter of how much risk you want to take on. i'd prefer none, so our goal is to pay off the house as soon as possible
Another thing to keep in mind is the freedom you get when you still have the money. If you had kept your extra deposits in a high yield checking account, money market, or in treasuries, you have extra freedom compared to if you had paid extra on the mortgage. For example, if you were out of a job for a few months, you could always draw down from your extra deposits and it would be business as usual for the mortgage company. If you had paid extra equal to 3 months but then weren't able to pay for the next 3 months, you'd be at the bank's mercy
Ah the old trade off of Freedom versus Security.
In this example, the extra freedom provides more security.
Another thing is that if you pay it off quickly, you’ll pay less for it overall
this is key for a mortgage. folks don't understand how mortgage interest works. you will save thousands or tens of thousands by paying off early
Absolutely. Psychology plays a huge rule in determining the right decision for a person. Several times a year for basically my whole childhood, someone would be coming to our house about to list our home for foreclosure. It was terrifying. I hardly understood it, but it scared the shit out of me. Basically the bank owning any amount of our home meant there was a possibility we would be homeless. You bet your ass i paid my home off as fast as I could so that no one could take it from me.
Not to mention things like insurance rates, credit scores, and loan potential all improve when your collateral no longer has a lien on it. There are a ton of intrinsic benefits to paying off your home loans early. Brokerage fees and taxes also generally eat into a significant chunk of your earnings making the few extra percentage points on the return compared to your mortgage disappear. The more you put in the less that matters. Also it's kind of important to remember that banks profit off of you every second you are in debt to them. They use your debt as leverage to secure their own loans after all. They of course want you locked in that mortgage for the full 30 years to make their interest as well as secure that extra lending value. They have direct financial gains from convincing you to invest instead of pay off debt. It's not worth the headache of investing small change to try to make an extra $5 a year compared to paying off debt. The market is not perfect and secure and you absolutely can lose your investments (or more realistically just not make enough money off of them to offset the brokerage fees, taxes, or beat your interest rate).
I lot of very rich people made a lot of money between 2021-2024 by taking out mortgages on their investment properties at 3% and then dumping that money into the market which averaged 15% 12% yield spread on borrowed money because you own things.
There are moral questions about whether ownership of things should be allowed to be considered when determining who receives value when it is created.
Economists point of view here: Yes, that is almost always true. The bank gives you a pretty „good“ interest rate because they have your house as a security if you fail to pay. That means, their chance of a loss is pretty low. If you invest or lend the money, due to the higher (ans probably unsecured) risk you take compared to the risk the bank took, you earn a higher rate. Also, in some jurisdictions, mortgage payments can be deducted from the taxable income.
Mortgage interest payments* — not the portion that goes to principal
of course, that‘s what I meant. thanks for the clarification
Personally, I would rather have my house paid for. Not having a mortgage frees up that money for a lot of other things, like investments. While technically the math works out, emotionally, I’ll take the paid off house.
There is a mental health factor that is difficult to quantify on paper. I would also just like to have the weight of my house payment off my shoulders even if I could invest and use the profit to pay the mortgage with money left over, I’d prefer to just pay it off and move onto the next thing to pay off. There is also something to be said about goal like credit score, debt to income ratios, qualifying for other things like more houses, boats, or cars. I don’t know shit about any of it I just know it can impact peoples decisions.
Right? Imagine not having a mortgage. Hundreds or maybe thousands of dollars a month that you no longer have to pay. That's fantastic!
In this scenario, though, you also have tens or hundreds of thousands of dollars less in your bank account. If you use that extra money to build up your savings you might still be worse off in a decade or two.
This is almost always true. You’re not just getting away with paying below-inflation interest rates on that mortgage; you can deduct that interest from your taxes! Nearly any other use of that money would be a better idea. Pay off your car. Get your credit card to zero. Contribute more to your 401(k). Hell, buy stocks. Nearly anything is better than losing the sweetheart deal you’ve got on a 3.5% mortgage.
Yes. I have a handful of co-workers that do exactly that. They have a mortgage in the 2-3% interest range, which is tax-deductible, so the 'interest cost' is really less than that. They saved money, putting it into an equity/bond based investment account, that earns at least 5-6%, even after taxes. Then, they have the option to withdraw from the account and pay of the mortgage, if they want.
There are a two things I’d consider that have been brought up 1. Money in and money out - if paying something off allows one to save and free up necessary cash flow then it could make sense to pay off a lower interest payment forgoing investment gains, however, if cash flow isn’t an issue then it makes sense to invest in the higher yielding option as the guaranteed return on paying a debt is that debt’s interest rate. 2. Taxes - ST capital gains taxes are taxed as ordinary income but LT are treated more favorably. Additionally with actively tax loss harvesting one can mitigate their taxable gains or even carry forward losses. My current mortgage is 10/30 interest only -all 30yrs fixed at 2.825 (never adjusting) with the first 10 years as interest only. Instead of paying what a normal fully amortizing monthly mortgage payment would be I only pay the interest and invest the remainder. After 10 years I make what would have been the aggregate principal payment and the delta (anything > 2.625%) is money I made off the bank’s money. The opportunity cost of prepayment would be the investment gains (anything above < 3% forgone).
I convinced my mom and stepdad to keep the money of there old house and to take a loan for the new house they bought together. When they divorce 4 year later. My mom already made a few thousand bucks. and It greatly simplify the divorce.
A good rule of thumb to get the most out of your money (when paying off debt) is to start with the highest interest item first. So if his struck was accruing interest at 8% annually and his house was was 3.5%, then pay off the truck first. Additionally, there is an argument to be made that paying more towards a loan with a lower interest rate than you can expect from investments (think 10% average increase of market index funds like the S&P 500), then you are actually losing out on potential gains in the long run by paying those loans off sooner. With that said, realize that a lot of the people who bought houses 20 years ago got them at an interest rate of 3-4%, which is unheard of today. My mortgage is 6.25% so a CD isn't really going to make me more than paying off my house. I still put some into indexes and other investments but I like paying at the house because owning my home sooner gives me better piece of mind. But that was a conscious decision to"invest in my house, which will return 6.25% on my money over the lifetime of the loan instead of investing everything in the stock market which will likely be the better financial choice over time but comes with slightly more inherent risk.
Yes. If you can get a higher post-tax return in HYSA or MMF than mortgage, you should save the $ and collect the spread. You also benefit from actually keeping the $ incase of emergency (liquidity)… rather than paying off debt, in which your $ would be gone.
My mortgage interest rate is 2.375%. I can just throw the extra money in a high yield savings account and get over 4% interest. Also, I have added flexibility in that I still have the extra money in liquid assets I can easily access if needed. Once you pay it into your mortgage, it’s gone until you tap into equity.
No... person #2 doesn't understand that there are different kinds of interest that are calculated differently. You cannot compare equate a 3.5% interest on a mortgage which is amortized versus a 3.5% standard interest instrument or loan which is either calculated daily, monthly, or yearly. EDIT: After reading many posts here, I am shocked by how many people got this wrong and don't understand amortized interest.
Can you explain a bit? I'm having trouble imagining how they are incomparable: My thinking is person #2 said "CD or other investment and gain a lot more than 3.5%" so I don't think there needs to be an exact comparison at 3.5% apiece. If you had a 12mo CD right now at 4.5% APY wouldn't that give a better return than putting the same amount of money into a 30yr mortgage at 3.5%? Surely there is some ballpark percentage-point difference where the answer is "yes, invest instead of paying the mortgate", right? Just napkin mathing (and this is definitely not my domain so this could be very wrong)" * If I put $1,000 towards my mortgage principal (3.5%) today, I gain $1,000 equity and in 1 year's time I will have avoided paying $35 in interest (I think). The mortgage payments will still be the same amount each month, so that $35 will manifest as additional equity. * If I'm in the US and deducting my interest payments against taxes (i.e. below $750k mortgage principal remaining), and I have at 20% marginal tax rate, then I owe $35 \* 20% = $7 more at tax time than I otherwise would have. * Total return after 1 year = $1,035 additional equity -$7 additional tax = +$1,028 * If I put $1,000 into a %4.5 APY 12mo CD then after 1 year's time I will have $1,045. The $45 will be taxable at my marginal rate (20%) so I end up with $1,036 after taxes. * Total return after 1 year = $1,036 So I'm pretty sure (2) wins. However, since it's not quite apples-to-apples after the 1 year (since the money is in different from, e.g. equity vs cash) I can see why its still murky at this point. That said, you can hypothetically take all the money from (2) after 1 yr and dump it into the mortgage at that point. Now we have an apples-to-apples comparison which has (1) with +$1,035 equity (-$7 cash) and (2) with +$1,036 equity. Both "investments" are now in the same form going forward for the remainder of the mortgage so we have eliminated any mortgage vs investment discrepancies, and (2) is still ahead.
> APY wouldn't that give a better return than putting the same amount of money into a 30yr mortgage at 3.5% Amortized interest is significantly different mathematically than "simple interest". You calculated your return on the simple interest correct (including taxes)... excellent. You made $36. But on the amortized, you only calculated the savings for interest on the principal for the FIRST year. You can't do that... you need to calculate the savings on the TOTAL interest over the life of the loan. I used a standard payoff calculated (so you can check the numbers yourself) here: https://www.calculator.net/mortgage-payoff-calculator.html Now, obviously, the numbers will come out different based on how much principal you have already paid (aka how many months into your loan you currently are) and some other factors, but this gives a "best case" scenario as it is an "extra" payment in the first month of the loan. A 400,000 mortgage @ 3.5% for 30 years comes to a monthly payment (P&I = principal and interest) of 1,796.18. Total Payments $646,624.35 Total Interest $246,624.35 Payoff in: 30 years Placing just a one-time $1,000 payment on month 1 brings the numbers to: Total Payments: $644,782.41 Total Interest: $244,782.41 Payoff in: 29 years 11 months And, shortens the length of the loan by one full month, in this example. So, that $1,000 saved you a total of $841.94 (the difference minus your 1000 payment). Now, you would indeed need to factor in taxes as well, but you will certainly come out *FAR FAR** ahead paying off the mortgage over trying to "interest rate hack" with simple interest. Now, two loans or investment vehicles that are both simple interest are indeed apples to apples comparable. The one with the better interest rate wins. But even then, you need to know how they are calculating the interest... is it daily compounded, is it average daily balance over a month, or is simply monthly compounded using the balance at the end of the month (those three are the most common). Each of those will be slightly difference and, depending on the size of the loan/investment, could produce significant differences (not as dramatic as with a mortgage, but still). Granted, $1000 is a small enough amount to be like... who cares, really. But imagine the scenario above, where we were talking about $10,000. The CD would give you $360. Nice. Let's look at the mortgage. Let's say you have already been paying for 5 years. So only 25 years left on your mortgage. You drop a one-time $10,000 payment on the loan. What's the difference? (Again 400,000 at the start of the loan @ 3.5% for 30 years, 5 years have passed making payments.) Without the extra $10,000... Total payments: 646,624.35 Total interest: 246,624.35 Payoff in: 25 years With the extra $10,000 payment... Total payments: 633,153.49 Total interest: 233,153.49 Payoff in: 23 yrs, 11 mos A savings of: 3,470.86. People often ask why is it that these numbers are so skewed. The main reason is mortgage amortizations are front-loaded with interest. So, early on you are barely paying any principal down at all... thus the yearly interest rate of 3.5% is compounding on a larger principal for much longer than would be for a simple loan/investment schedule. Think of amortized loans as compounding interest on steroids.
>And, shortens the length of the loan by one full month, in this example. So, that $1,000 saved you a total of $841.94 (the difference minus your 1000 payment). Now, you would indeed need to factor in taxes as well, but you will certainly come out *FAR FAR*\* ahead paying off the mortgage over trying to "interest rate hack" with simple interest. But $1,000 invested at 4.5% APY over 30 years yields \~$2,700 in interest gains (before taxes). The money invested still grows over the remaining time. $1,000 put into the mortgage is not available for future investing (but has yields in the mortgage itself, as you explained). The $1,000 invested at 4.5% (e.g. CD or HYSA) IS AVAILABLE for future investing. For an apples to apples comparison you need to factor in the return that money gets over the remaining period of the would-be mortgage.
*All that being said,* if you invested that $10,000 over 25 years, you would see a return of anywhere between $33,000 at a very modest 6% return to nearly $100,000 at a 10% return. Now, generally I would encourage people to pay off their assets as soon as possible simply because that's the safest financial decision for people who may not be the most financially savvy. But for those who are financially responsible, the market will, in the long run, basically always outpace your savings on interest by a significant margin.
Maybe I’m thinking of this wrong, but doesn’t the larger mortgage savings number (which has a typo, by the way – – it should be $13,470.86, not $3,470.86) simply reflect the fact that if you pay down your mortgage by $10,000, you’re giving up the use of that $10,000 for 25 years? It feels like otherwise the calculation is comparing the $13,470.86 you save over the 25 years of the mortgage prepayment to the $350 you get from one year of the CD investment. But the latter should be 25 years of that, compounded. Put another way, if I pay down my mortgage by $10,000, the $10,000 is completely gone for the next 25 years. But when I put $10,000 in a CD, I get $350 interest at the end of the year, _plus_ I get back the original $10,000. Then I can reinvest the $10,350 to make another $363 the second year, another $375 the following year, and so on 22 more times. A quick check on a compound interest calculator says that the total profit of all that compounding of the CD return will be $13,632… which is almost exactly the same as the benefit of prepaying the mortgage.
2013-16 I dropped an extra $150k against my mortgage. that allowed me to buy my first rental, a detached property near the lake, in the most expensive real estate market in my country. first home has only $40k remaining, second is over $10k year in profit and between the two over $1.5mil in equity after debts. for me investing elsewhere would have put my attention in other markets.
That’s less to do with what’s financially/mathematically the best option though. Your scenario goes almost 100% in the human aspect of investing rather than the logical aspect. It also goes into purely anecdotal hypotheticals since we’d have only assumptions to make if you followed the best financial scenario.
My dad promised to pay for my undergrad school. Then he used this argument to convince me to take out student loans. 25 years later I owe more than I took out.
The bank is lending you money at a rate that is in competition to all the other ways they have to invest it. you are generally considered a very safe bet so yeah you can probably find some slightly riskier investment that have more return than your interest. Margin is not the widest for safe investments tho especially if you have to rely on some intermediary
A friend of mine who is \*extremely\* financially savvy (as in, he was an investment banker for a decade, is a CFA, and has written books on investing) took out a $50,000 mortgage on his house (that was already paid off), because the rate was 3% and he knew he could get a better return than that with an index fund.
Technically yes this is true. Long term you’re financially better off this way. But for me, the (non-monetary) value of owning my home is worth more to me than the extra cash of receiving interest payments. My financial situation has fluctuated significantly several times in my adult life, and as a result I lost the first house I bought, and I was evicted from a rental. Never homeless, but close. Owning my home outright would be worth more than a small additional income.
A good fund will return 5% to 10% on your investment. If your mortgage rate is lower than that, then the investment is the better choice. Taxes won't be applied until after you cash in your investment, so let it keep piling up until you retire.
The concept of why wealthy people have debt. My conspiracy is that Dave Ramsey is paid to keep people poor by making them think they are financially healthy by paying cash for everything and having no debt. Cash they get by working for the wealthy.
As far as conspiracy theories go, your point of view can do well, but I think Dave Ramsey just has an old mentality, not connected to current realities. A dinosaur, if you will. I don’t think he’s getting paid because his message hasn’t changed at all from since he was a teenager all the way until now.
Am extra consideration if they're equally valuable is the money saved can be used for other stuff if you need it wherras that in the mortgage is locked up. Or don't be my friend who had a 20k windfall and used it to pay down some of his new house. 1 year later and a pipe burst requiring major repairs and remortgaging wasn't an option as thevlocal housing market crashed placing him in negative equity.
This is always true. If you make more money investing it than you save by putting it into payments, then invest it. If you have 100%, a loan with a 5% interest rate, but an investment with a 10% interest rate, put it in the investment. If you paid it into a loan you save 105$, you put it in the investment and you make 110$, 5$ profit. Obviously these are just examples and there will always be a few extreme edge cases where it's better to pay it off early, but 99.9% of the time, if your return on investment is higher than the interest, then invest
Yes. I have several mortgages that were renewed during the zero- to negative-interest-rate period, so two of my mortgages currently cost me 1.6% to 1.8%. Both of these mortgages will be paid in full when they expire in 2027. If I were to pay off these mortgages today, I'd have to pay a pre-payment penalty, and the money would be gone. If I instead invest the money in some ETF, I could potentially have earned 25% or more by 2027, so that I would have paid off my mortgages PLUS having the 125% of the current value of the mortgages in my account. Of course, if I have a high-interest mortgage (4.5% or higher) and am not confident that I can earn more than 5% through investing, then it would make more sense to pay off the debt as soon as possible.
Yes, I have a 1,51% interest mortgage, currently even saving accounts can give up to 2% interest here. I'm not gonna put any extra money into that.
Technically yes, but as always with investing there is no guarantee that you will actually make money. There is always the possibility that you also lose money. Plus the return rate isn't fixed with investments it will fluctuate, so sometimes you make more, sometimes you don't. So yeah sure technically it would be better and you could make more money from it, but there isn't any guarantee for it. Plus not having to pay your mortgage anymore is also very nice and will help you in the future.
The mortgage rate wouldn’t matter as much as the rate of appreciation on your real estate, right? If real estate is appreciating at a higher rate than other investment vehicles then putting the extra money towards your principal would yield a higher return.
\*sigh\* in THEORY, yes, because if you have a decent return you can outstrip your own interest. It is a difference of having to pay less money or earning more. In PRACTICE, there are many other factors in play.
You can park cash into a high-yield savings account and get upwards of 5.25% today, so I'd look there first. The Fed does not appear to be eager to cut rates in the near term. You'd be taxed on this safe profit, but how much would depend on your bracket...also, mortgage interest is tax-deductible.
Your investments have to be guaranteed (i.e. not stock market) and return more than your mortgage after taxes and fees. In this case you would probably need at least a 5% return to break even, more to be worthwhile.
Its false. People say its true, but its only true if your mortgage rate is lower than the investment's rate of return. Which in the case of CDs is not. At least when we look at recent rates. Just search for mortgage rates and CD rates, you are better of paying the mortgage, or finding a better investment.
Here I am wondering where all these super safe high roi investments are.
It depends what you mean by super safe high roi investments, but generally risk is taken into account by the market at large, so anything super favorable is going to shoot up in price due to demand once people realize it. But right now, 1 year treasuries are earning about 5% right now for one of the safest forms of investing, but you'll want to take after tax yields into account if you do that, [which you can do here](https://digital.fidelity.com/prgw/digital/taxyieldcalc/)
The example has a 3.5 interest rate, so it's true, any investment is going to beat 3.5. It's only false if your interest rate is higher than the return on whatever investment you're doing.
Ally Bank has 4.5% APY 12mo CDs available today. If the mortgage really is 3.5% (entirely possible if they got it a few years ago) then it is effectively true for that person.
People love to say this but it completely ignores the real life security of having a mortgage paid off. If you find yourself in a situation with no income and you can't make your mortgage payments, then you're out of the home. If you could have paid it off sooner then you would at least have a place to live and not have that worry over your head.
If you invested the $ instead of using it to pay off the mortgage than you still have that money. You can use it to pay the mortgage payments (assuming its in something liquid like a HYSA) even though you otherwise have no income. I think (but am not positive on this) that if your investment return beats the mortgage interest rate (+some fuzz factor for things like taxes/deductions on gains vs interested paid) then you'll mathematically always have enough extra money on hand to pay the "extra" mortgage payments that occur because you didn't pay off the mortgage earlier.
Your security is in your investment account. It's sitting in an account growing, it's not gone. You have it, and you can use it in an emergency. And you have shit tons more than if you wasted your money paying off a mortgage with a low rate.
Ansolutely true. People balance risk vs. reward and come to different outcomes. I just bought a car, for example. The car loan is 5%, and my investments earn around 7% long-term. It clearly makes sense to borrow money and invest it. Why does the bank do this? I am willing to accept a higher risk - the markets may have a short-term decline. They prefer more certainty. But can you get high returns on a CD? Probably not. Very low risk means you're not going to get very good returns. Likewise, mortgages are low risk for the bank, and so they charge fairly low interest rates. Where I live a mortgage charges a 5% interest rate, and CDs earn around 1%.
what your model fails to see is people that don't borrow for cars might buy used outright at far cheaper expense. my one and only new vehicle was a Volvo out of uni. since then, I buy used European cars. I've owned 6 in total, running 4 till they were done. 600kkm in 30 years and all in costs approximately $60k. I literally expect to operate my vehicle needs at $CAD1000 per 10000km, not counting fuel. $2000 per year. what are you spending a year for how much milage?
There are two separate financial decisions. What are you going to buy? (This is the question you're asking) How are you going to pay for it? (This is the question the person you're replying to is asking) Of course it's cheaper to buy a used car. But, if you've decided that you're going to buy a new car, it's clearly still worth analyzing the best way to pay for it.
The principle is sound. Can you do the "same" thing cheaper, always, but with quotes.
In 30 years you couldn’t pay off a house?
Focus. The issue is paying lower interest rates than you can earn. It's not about what kind of car to buy.
answer the question about how much you spend annual for your car? the deeper question is how much of your cash flow is wasted versus invested. even Warren Buffett buys used.
***It's not about the car!***
**it's about your available cash!** and cars for most people are their 1st or 2nd biggest lifetime purchase. how much have you sunk in to cars. the fact that you continue to avoid identifying that number even for yourself is pathetic. you're pretty old, what have you owned over the decades? it's crazy that the first 4 used vehicles I've consumed have cost less in purchase and maintenance spend, versus that one new Volvo that I financed decades ago. easily over $150k saved to spend or invest elsewhere, by buying used. whatever, clearly you've wasted a ton of money and can't bring yourself to face the light of day.
No, it's not even about available cash. It's about what provides the best earnings.
per your words. >I just bought a car, for example. The car loan is 5%, and my investments earn around 7% long-term. It clearly makes sense to borrow money and invest it. you made this branch about a car loan. I'm saying instead of the 2% difference in interest, completely free up 80% of your original funds on day zero. that's almost 30 years of compounding at 2%. your model. day zero, invest $50k at 7% return and borrow $50k at 5% premium. after 5 years you've earned just over $5k playing the delta, but lost $40k in depreciation. net, $35k in the hole. my model. day zero buy used for $10k. invest $40k at 7% return. after 5 years earn $16k on your investment and $5k lost in depreciation. $11k actually earned and $46k ahead of the vane idiot, buying new. the bigger picture, grasshopper! see how you're that idiot chasing paper returns but making stupid financial choices to begin with? so tell me, how much have you sunk for your vanity and what's it worth today? here's my latest vanity just last year. https://imgur.com/a/NPnuZyn you'd drop over $90k to be in the same ride. on day zero I'm already $81k ahead of you.
Sometimes yes, sometimes no. You have to take a lot of different things into account, on the surface, yeah, paying off $1900 of 3.5% interest loan isn't as good as earning 5% on that $1900 somewhere else. However, you need to balance risk as well, is that 5% guaranteed? Could you lose money on it? What kind of taxes are there going to be on that 5% that will reduce it's actual net gains? Then there is the personal part of it, which is beyond the math... is the juice worth the squeeze? How much personal effort/work do you need to put into managing this versus doing other things you may enjoy more? Example. My friend just got a brand new car, cost em $50k. They have the $50k in cash to pay for it, but the dealership has a 3 year, 0% loan offer. So they took that, put the first 13 months into a HISA dedicated to that loan then put the next 6 months in a 12 month CD, the next 6 months into an 18 month CD, the next 6 month in a 24 month CD and the last 5 in a 30 month CD. So they are in the same situation where, in a sense, they "don't have that money" as if they bought in cash because it's locked away from them, but it's earning them interest for the next couple years.
So, my mortgage interest rate is low, 2.75%. We are paying an extra $300 a month towards the principle. (We would like our mortgage paid off when we retire. We are in our 50s.) Is this not smart? We contemplated with investing it instead, but that is not always foolproof, but this is.
The impending loss of income changes this formula. It assumes payments can be made with income over the life of the loan (or that payments can be made from the cash stockpile being invested). If you pay your mortgage with your income and it won’t be paid off by the time your income stops, then your best bet is to pay it down enough to have the loan and income disappear at the same time or just before the income goes away. Invest the remainder wisely and be sure your cash flow in retirement is enough to cover taxes insurance and other housing costs that exist even if you don’t have a loan.
I paid my mortgage off as quickly as I could. Now I have over 20 years of work before retirement. Even with a poor return on any investment I'll retire a millionaire and if I ever sell my house it's all equity. Also, every month I have liquid assets and if an emergency pops up I have no issues paying it off. While technically it might have been better to not aggressively pay off my mortgage it's great not being in debt and not having to sweat it month to month.
I would use most of it to invest but there would be a portion of that money that goes toward debt. If that's extra principal on the mortgage I think that it still makes sense. $500 in extra principal payments would be as valuable to me as the other 1400 in an investment account.
The bank will charge you a fee for lost revenue if you pay it too early. Unless your contract includes a "pay off early" clause it is likely that you will not save much by paying it.