Should I Pay Off My Home Early?
Read Time / 3 Minutes
Theme / Financial Planning
One of the questions we often get asked in our business, is should I pay off my home early or prioritize my retirement/investing? I wanted to walk through some of the math with you today to help shed light on this decision. Let me also preface this by saying that all figures discussed here are hypothetical and are not guarantees of potential returns. This is purely for educational purposes.
For a second, let’s imagine the following hypothetical:
15 years ago, you purchased a $500,000 home with 10% down at a 4.5% interest rate. You’ve been doing minimum payments until now and are left with $285,000 due on your mortgage. You recently got a raise and have an extra $500 a month to either invest or pay of your home with. What should you do?
If you were to take the $500 per month and put it towards your loan payment, you would have your complete balance paid off in 12.5 years (saving you 2.5 years of payments!), now you have an extra $2,700 each month to live/invest with that you didn’t before. By the time your initial pay-off date comes, you will have paid off your home and been able to save/invest $108,000 from the money saved on your mortgage payments.
Now, let’s say you invested that money. If you were to invest $500 a month into an index fund that produced 10% annual returns over the next 15 years. By the time your house is paid off over those 15 years, you will have also accumulated $207,000 from your investments.
In this scenario, the mathematically optimal option is choosing to invest that excess funds, and if you’re someone who wants the mathematically optimal solution to your finances, your retirement/investments should likely take priority over paying off your home early. This is why Dave Ramsey makes investing 15% of your income towards retirement his 4th baby step and paying off your home early the 6th baby step.
So, why do some people decide to pay off their house with that excess income, instead of investing? The answer lies in an economic tool we call utility. Utility is the non-financial gain someone receives from a financial decision. It’s why someone is willing to eat out for $25 instead of making their own dinner for $7. There’s more than $18 in utility to that decision to eat out.
In the case of paying off your home, the utility can come from a few areas:
o Some people enjoy the certainty of having their home paid off. That way no matter what happens with their work/life, they know that they own their home. P eople are willing to make certain financial decisions for the sake of peace of mind.
o Personal experience with debt may cause someone to prioritize debt payoff over any potential gains elsewhere
o And of course, there is no guarantee for 10% returns in the market. Your interest rate is locked 4.5% in this scenario, so if the market had multiple bear cycles over this 15 year period, and returned 4% annually, it becomes mathematically optimal to have paid off your home. Some people don’t want to carry on this investment risk.
What does that all mean for you? It means its your decision. Weigh the potential pros and cons of where you’re putting your money and speak with a financial professional to help make decisions, if needed.
Of course… You can always do both, put $250/mo. towards your home and $250/mo. towards your investments.
Nathan Carroll
Registered Assistant
208-918-8655
nathan.carroll@christianwm.com
