Should I Pay Off My Mortgage or Invest? (We Did the Math)

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

Scott:
Thanks, Mindy. Great to be here at this topic is of simple interest to me and I look forward to discussing it with you today.

Mindy:
I love it. Alright.

Scott:
Oh, that’s right. BiggerPockets has a goal of creating 1 million millionaires. You are in the right place if you want to get your financial house in order because we truly believe financial freedom is attainable for everyone no matter when or where you’re starting, including whether you have a mortgage and can’t decide whether to pay it off or invest. In this episode, we’re going to talk about how you should be looking at your portfolio to determine when and if paying off your mortgage is ever a good fire decision and whether the fire math supports that. We’re going to discuss a quick refresh and how to calculate your FI number. We’re going to talk about how to determine when and where some folks may consider paying off their mortgage or not, and we’re going to discuss how that can affect your timeline to financial independence. So Mindy and I obviously disagree. A lot of this will be a debate. Mindy, I would love to open this up by hearing why you shouldn’t pay the mortgage. I think you have prepared a lot of math and a big argument for that, which I will dissect shortly.

Mindy:
Okay, so I have actual real life examples for why you should not pay off your mortgage. But before I give that, I want to caveat this is only for people who are considering paying it off versus considering keeping it. If you have financial trauma in your past that just does not allow you to sleep at night without having a mortgage paid off, then this conversation is not for you. This conversation is for the people who truly aren’t sure should I pay off my mortgage or should I invest? So Scott, my true life story, I was born in a small town. No. Okay, fast forwarding to 2019, back when interest rates were still really low, I was able to purchase the house that I am recording from right now for $365,000, which was a huge discount because it was gross as my houses tend to be.
It was a smoker’s house. So they had smoked in this house for 40 years. The carpeting was just holding in all this stuff. It was horribly outdated and nobody wanted this house, so it was already sitting for a long time. The sellers were getting very anxious and in order for me to be able to get it for such a reduced price, I had to be able to close quickly. So I rated my 401k in the form of a loan, not in the form of cashing it out. I rated my 401k, my husband’s 401k. I got a line of credit on my other house that I had been living in and I sold a collectible car to gather up all the cash so that I could pay cash for it and close very quickly.

Scott:
You didn’t sell your Tesla stock?

Mindy:
I sold my Acura NSX. Got

Scott:
It. Okay.

Mindy:
I think we sold Tesla stock to buy the Tesla car. But anyway, so we bought in September of 2019 and then six months later we cash out refinance. We pulled out 80% of the value of the home and grabbed that cash. So now we have a mortgage. Our mortgage is at 2.875 and I know that interest rates have gone up, but this is what happened with me. So we pulled out $319,000 and since then we have paid $31,500 in interest approximately, but we took that 319, we put some of it back into pay off the 401k loans. We invested $152,000 in a variety of things. That 152,000 is now worth $322,000, which is a gain of about $170,000. We invested mostly in funds like V-T-S-A-X and VGT, which is Vanguard’s tech fund. We also bought 40 shares of Tesla. Now Tesla has far underperformed the funds including V-T-S-A-X, but V-T-S-A-X has far underperformed the VGT that we put it in.
If we had put it all in V-T-S-A-X, we would only be up $140,000. And also note that we took that 150,000 and paid off the line of credit and the 401k ones and all of that. So if we’d invested the entire 319,000, we’d have a whole lot more, but we would also have paid a lot more interest because the home equity is a variable rate and we were just like, yeah, I want to close this out, pay this all off. So I am up $170,000 simply because I have chosen to have a mortgage and actually if we’re going to be fair, I’m up 140,000 because I’ve paid 30,000 in interest. So that is my argument, Scott. But I’ll also caveat that I have heard people say, oh, the reason that I want to pay off my mortgage is because if I didn’t put the money into the house, I would spend it and I’m technically not spending it. I’m investing it. Alright,

Scott:
How are we doing? Is it time for me to react to

Mindy:
It? Is time for you to react?

Scott:
Let’s get something off the books immediately. If you pay off a low interest rate mortgage and the stock market, for example, an index fund returns anything close to what it’s returned over the last a hundred years on a go forward basis, you will have less wealth at the end of 30 years paying off your mortgage than investing in the stock market. So no one is arguing against that. The only way you’ll have more wealth paying off your mortgage is if the stock market goes nowhere over the next 20, 30 years, which I don’t believe. So my argument is not for how to amass the largest net worth number. My argument for paying off the mortgage has to do with the math of fire. So let’s use your mortgage specifically as an example. Here you have a mortgage of $319,000, right? Okay, 319,000 and I believe you said the mortgage rate was 2.875%.
Okay, so your monthly p and i payments are $1,324 $1,324 times 12 months times 25, which is the 4% rule. So a big implicit assumption here. Here I’ll actually take one step back times 1,324 times 12 is $15,888 per year. Now to fire one typically needs, the rule that we always come back to is the 4% rule. So one would need 25 times $15,888 from their portfolio in order to comfortably retire using the 4% rule, that implies a balance of $397,200 in your portfolio of stocks and bonds. In order to distribute the $15,888 per year you need just for p and i. So if you’re close to fire, you don’t have this problem because you’re so far past fire, you have so much more wealth than you need to feel comfortably retired that you can just optimize for even longer term wealth and not ignore this problem in general.
But someone who is close to FI would accelerate their journey by paying off the $319,000 mortgage even at that 2.875% range early because it would reduce the total balance of wealth they need to fire by $70,000. How’s that for some interesting fire math here? Now that gets even more extreme. Obviously you have a low interest rate mortgage, but if you have a 7% mortgage, let’s do the math here for this one. So that’s a $2,122 p and i payment. So 2,122 times 12 times 25 is $636,000. So paying off this $319,000 mortgage balance at 7% accelerates your FI journey by an incremental 320 some odd thousand dollars. And that is the phenomenon that really has been interesting to me over this time is yes, there’s an opportunity cost in 30 years, someone may have less wealth, but is even that opportunity cost as big as we think?
Because when we think about the fact that someone needs to generate $25,000 per year on that $319,000 mortgage at 7% for example, is the opportunity cost with the stock market really that large, right? There are tax considerations. One has to factor in here in order to generate $25,000, one has to realize income in some form, whether it’s a capital gain or dividend or ordinary income going in the most conservative case, a capital gain might be taxed at a 10 to 20% rate. For a fire person that’s probably going to be in the higher end of that range, let’s call it 20% plus your state tax, four or 5%. So now your 10% stock market return is really only 7.5%. So you have to generate a 10% pre-tax return to pay the 7% tax rate on your mortgage, a 7.5% return that’s highly volatile in the stock market and maybe not certain, maybe not something that you really want to plan on or guarantee yourself.
That’s not enough of a spread for me to pay off. It’s compared to a guaranteed reduction, a guaranteed 7% interest rate on a mortgage and following that math, the house I’m sitting in and recording this podcast from is one that I purchased this year and I chose to not use a mortgage. I chose to just buy it in cash instead of investing in the stock market or an alternative because of that concept here. If I was going for the largest possible long-term net worth number, no way would I have done that. I believe I could have gotten a spread in real estate or something else compared to buying this house, but I have peace of mind a guaranteed return here and it’s a two-way door. This rescission is not irreversible. I can always take out a mortgage if interest rates go down in the future and reinvest that in something else like real estate stocks or an alternative.
So that’s my fire math. I think I have two more points here and then I’ll shut up on my monologue. I think that I want to caveat this as if I was starting over my journey to fire, there is no way that I would say, oh, I’m going to buy a house and pay down my mortgage, right? This is not a good tactic for someone starting on their journey. But I think that for someone who’s close to fire, even if they have the 2.85% mortgage, that paying that off may be the thing that actually moves them over the edge and gets them comfortable with financial independence. There is a model that I need to build here to calculate that. I wanted to have it done for today, but I didn’t have a chance to do it and sometimes I’ve delayed on these types of discussions for months and months and months until I actually get around to building this thing out. But I know that once I build that and model it out, that it will show that a new person starting out from zero or the first a hundred, 250 k and looking to move toward fire should not pay off their mortgage if they want to maximize their chance of getting there quickly. And I know that people who are close to fire will be able to finish the journey per the 4% rule a little faster in many cases if they choose to prepay their mortgage. So how’s that for,

Mindy:
I hear what you’re saying and I have some questions.

Scott:
Alright. We do have to take a quick break to hear a word from our sponsors, but when we return, we’re going to continue getting into the nerdy pre and post-tax math of paying off your mortgage versus putting it into alternatives like high yield savings accounts.

Mindy:
Welcome back to the BiggerPockets Money podcast. Let’s jump back in. So first off, you said if you were just starting your journey, you wouldn’t pay off your mortgage, but if you’re close to fire you would. What does close to fire mean in this conversation?

Scott:
Let’s go back a couple weeks to Emily and Justin from the middle class trap episode here. I think that was episode 5 43 of the BiggerPockets Money Show podcast. So we’re talking to them, their $1.5 million net worth. Their mortgage is probably in that 2.85% range, maybe a little higher, maybe a little lower, but in that low interest range. And they’re like, how do we get out of this portfolio that’s not producing any cashflow or lessen the pressure on ourselves to just earn a bunch of income? Well, that’s a really compelling position or really compelling situation to say you should just pay off the mortgage potentially, because if the goal isn’t the highest possible long-term net worth, but the feeling of financial independence and unlocking bits of the portfolio, that’s an easy lever, right? That unlocks 20 or 25 years potentially of a lower demand for income generation for that during the best years of your life, you have a lot less pressure on your household to generate income to maintain a cashflow positive situation.
So I really like that. Also, I want to call out that some folks run the opportunity cost on paying off the mortgage incorrectly because they’ll say, oh, you take that 300,000, you invested in the stock market and you get this huge number. Well that’s not a fair comparison because what you’re doing is you’re taking that 300,000 and you’re prepaying the mortgage, but then every year, Mindy, you can invest the $15,888 in the stock market. So you get a good chunk of it back. There’s still an opportunity cost at the end of it, but it’s not $300,000, three $19,000 compounding at 10% for 30 years versus nothing. You can still invest in the stock market on the alternative there. And so it’s a much lower spread than a lot of people compute back at the napkin in terms of that opportunity cost. So anyways, in that situation, I think that there’s a very good argument to be made for paying off the mortgage, and I think that argument is only that much more powerful for folks like me who bought a house in 2024 or 2023 with the higher interest rate environment.

Mindy:
I will give you that. The higher interest rate environment would definitely give me a different thought process. And you said something, it isn’t 319,000 versus nothing and think that’s really important to point out. I think a lot of people don’t calculate these numbers correctly. They think in terms of absolutes it’s either 319 or it’s nothing. And that’s not true and I am just as guilty as anybody else of thinking in more absolutes. Scott, what is your opinion of taking the difference? Let’s use my $1,324 a month PI payment and let’s say I wanted to make a $1,500 a month payment in order to pay that off. What is your thought of making the 1324 and then taking the 1 76 and putting it into a high interest checking account or a high interest savings account so that I have access to the money, I’m still making this additional payment, I’m just not paying the mortgage company that I am making more an interest. Now somebody pointed out that you are going to pay taxes on that interest.

Scott:
Yeah, that’s my big problem. So in Colorado, someone who has the ability to generate $319,000 in cash is likely in a moderate to high income tax bracket. So someone who’s capable of making this choice, which is most of the people who we’re talking about on this episode, a third of the people listening to BiggerPockets money are millionaires and are likely to have some version of this problem in their lives. So this is not for everybody. This is not for somebody who’s starting out. You’re like, oh, privileged to discuss paying off the mortgage or investing. This is for folks who have the choice to make there, but let’s say your household, Mindy, you’re talking about this, you’re going to earn 5% if you’re doing a good job in your high-yield savings account, that would be a good high-yield savings account. You have to probably move your money pretty frequently to sustain that because they always dip and dive in various banks.
I think Ally right now in my account is like 4.75 or something like that. But let’s say you’re good and you get 5%, okay, in Colorado, the highest tax bracket is 43.8%. When we blend federal income tax, state tax, Medicare, Medicare and Medicaid, and then social security. Okay? So that is going to cut your return from 5% to a little over 2.5% in terms of the yield on that, which is lower than the interest rate on your mortgage right now at 2.85%. It’ll be some difference there. You like probably most other people in this situation probably just take the standard deduction so you’re not itemizing your mortgage on this. So it’s a true net negative arbitrage to put that money in a high yield savings account in my view, compared to paying off the mortgage in a situation like yours.

Mindy:
So in my situation, because we’re talking such low interest, I would still, I was in this position of I wanted to pay off the mortgage earlier and I used to be in this position and I’m no longer, but I would still put it into the interest bearing account versus putting it into the mortgage for the sole purpose of being able to access those funds if I needed them. Once you put them into your mortgage, you have paid down or paid off your mortgage. The only way to tap into your home equity is a home equity loan, another mortgage or a home equity line of credit, all of which come with a much higher interest rate than what I am currently paying on my mortgage and even what I would be paying with regards to putting it in the account. So I would say if you are in this position where you are not financially independent, you don’t like debt and you have a lower interest rate mortgage, consider putting it in there, even giving into account Scott’s tax bracket math, still put it in the high yield savings account. That’s what I would do just because I want to be able to access that money.

Scott:
Yeah, well look, I just look at it as one pool of money. I’m a little bit more cold in calculating and the way I think about the assets here it is just, let’s say this person likes to have $1.5 million like our couple Emily and Justin from that episode a few weeks ago. Well, how do you want that to be distributed? Right now it might be $400,000 mortgage against $600,000 home plus some stock investments in various retirement accounts plus some cash plus a little bit of real estate. Well, it’s just how do you want that distributed? And I’m arguing basically for allocating some of that pie to the paid off house in the situation because of the reduced pressure it puts on the rest of the portfolio to generate income, the feeling of freedom that it will engender and the better tax advantage returns than putting all of that in his high yield savings account.
Now if Emily and Justin or whoever’s listening to this is saying, I want to be an entrepreneur, I want to go buy a business or I want to buy another rental property and go flip it or do something that is generating truly high returns cash all day. But if you’re a passive investor that just has a high, wants a higher amount in savings, I think there’s a potential mistake being made there because you’re negatively arbitraging the interest rates after tax considerations are taken into account. And I think that if you can do with a lower, I have a paid off house, Mindy, I can get a HELOC anytime I want. I don’t need to have quite as much cash in there in the event that I needed cash, yes, I’d be paying a higher interest rate to borrow a heloc, but for the rest of the time I’m not paying 7% interest on my mortgage. So I think that there is a very good odds of that being a really positive spread there. So I think that that’s the way I would politely debate your point there

Mindy:
And I appreciate that. I appreciate the politely debating, even though I called you totally wrong about mortgages at the very beginning of this show. I do see argument on both sides and I can understand why somebody would want a paid off mortgage and in the current interest rates, I just wrote an offer on a house for a client and they said we’re going to pay this mortgage off in six years. We don’t even care what the, in fact, they took out a seven year arm because a seven year adjustable rate mortgage is less expensive interest rate wise than a 30 year fixed or even a 15 year fixed.

Scott:
So this is another point here around the other advantages that come with the decision to pay off the mortgage early, like the ability to use an arm. If that’s not your plan, that doesn’t make any sense. Why would you get an arm if you’re not intending to pay off the mortgage, right? I mean, you’re just exposing yourself to a lot of interest rate risk on your lifestyle to a large degree. I mean, yes, I know that there’s people who will give me a mathematical argument for that. That’s not something I would do. I don’t really, the home is a little bit different for me than the other parts of my investment portfolio now that I’ve decided where I want to live. But there are other advantages as well, which include things like insurance. So my insurance policy on my house is actually cheaper than the insurance policy on some of my rental properties, which are maybe a lower value in certain situations because I can just choose to have a much higher deductible, which is a couple percentage points of the home value because I only need catastrophic insurance on the house.
The lender might not accept that on a loan. So I have a much cheaper insurance policy, for example, with the paid off house. So there are other advantages that accrue as well, getting those expenses as low as possible. Alright, we got to take one last break, but stick with us. You don’t want to miss a couple of practical additional considerations that have to do with paying off the mortgage early while we’re away. Make sure to hit that follow button so you never miss an episode of the show. Or if you’re watching on YouTube, hit that subscribe at button and give us a thumbs up. Alright everybody, we have a special offer for BP money listeners because we’d love to meet as many of you as possible at the BiggerPockets conference. So for 1500 bucks, you and a guest can attend the 2024 conference in Cancun, Mexico this October at the all inclusive five star resort of Moon Palace. That’s three all-inclusive nights, October 6th, seventh, and eighth, and full conference access for you and a guest. And the ticket also comes with a one hour private call with me and Mindy before or after the event. This call can be about anything you want including a for entertainment purposes only. Of course, private finance Friday.

Mindy:
This offer is first come, first serve and will be given to the first 10 BP money listeners to receive the offer. Please email our events director [email protected] and let her know you heard about the offer on BP money. Okay, now let’s get into the show.

Scott:
Yeah, I only want to be tapping my insurance policy if the place burns to the ground or I have a huge disaster, I don’t want to be tapping it for a $20,000 problem there. I can insure against that and save thousand, 2000, several thousand a year on my premiums by increasing that deductible to a point that would not be allowed by a lender.

Mindy:
Yes, and in fact, I have experience with that because I tried to increase my deductible to $10,000 and my lender said, oh nope, we don’t like that. You can only have a $5,000 deductible. And I thought, well, what does it matter? I have the funds to pay the $10,000, but because they hold the mortgage, I now have a more expensive homeowner’s policy because I chose to have the mortgage and that’s a good point, but I’m still up $140,000 with my investments.

Scott:
Yeah, look, I mean, yes, if you go back, it’s all about what you believe going forward. And I believe that the stock market is going to return close to its historical average of 10% per year over the long run. I believe that my pre-tax net worth will be higher if I invest in the stock market instead of paying off the mortgage. I believe that post-tax, the opportunity cost is actually going to be pretty low and tax brackets for capital gains and dividends are going to go up not down over 30 years, which is a complete guess, but just how I feel about it making that spread even lower. And I believe that again, that opportunity cost is overstated by a lot of people who are silently arguing against me because they did not factor in the fact that I will be investing the cash flows every month when I don’t pay the principal and interest payment. I’m investing that in the stock market or in alternative investments that are likely to perform reasonably well. So again, that’s just my position on the situation and it’s a privileged position to have, but it’s also just part of the fire world. This is a decision that most of the people listening to this podcast either are making currently in favor of keeping their mortgage or will have to make in five or 10 years when they begin to approach fire.

Mindy:
And I think that it comes down to what is your personality type. Scott and I are very, very different people. He is very cerebral, very cal, very much. You called yourself cold. I won’t call you cold, but you look at things black and white. I am far more passionate and fly by the seat of my pants. And it just depends on what your risk level is, what your comfort with debt is and what your brain will allow you to think about.

Scott:
And I also want to keep reminding the math here also says that it should be different at various stages in the fire journey. I’m not going to sit here and tell someone who’s got a median or middle, upper middle class income and starting with less than a hundred thousand dollars in wealth that they should pay off their mortgage as the fastest way to pursue financial independence. That is not true and that should not be to takeaway from this. That’s fine Advice from Dave Ramsey. It’s a good slow and steady approach, but that’s not what I’m saying. I’m saying that someone who is close to fi, probably well over the million dollar net worth Mark May find that paying off the mortgage accelerates their completion of the financial independence equation. Having a portfolio that is 25 times the amount of their annual household spending paying off the mortgage may be a big step in completing and satisfying that equation earlier than not paying it off. And you should really run the math for yourself there.

Mindy:
Okay, well, you know what I want to hear from our listeners. Have you paid off your mortgage or have you specifically not paid off your mortgage and why? Either direction. No judgment. Scott and I will not judge you and none of our listeners, if you share this in the Facebook group at facebook.com/groups/bp money, none of our listeners will make fun of you. If they do, tag me and I will come in and boot them out because this is definitely a personal finances, personal kind of the height of the personal finances, personal conversation. If you want to pay off your mortgage, ultimately I’m not making your mortgage payments for you, so go ahead and pay it off. Scott’s not making ’em either, so you can keep it if you want.

Scott:
And for the record, despite the math that I just described, or with the fire, I only paid off the mortgage in my primary, which would’ve been at the higher interest rates in today’s environment and I have not paid off the mortgages on my investment properties. Now part of that is because I still work and I’m well past my fire number so I can take the better long-term returns that come with leverage on an overall basis. But I don’t want to tell folks that I necessarily would’ve done this at if I had a 3% mortgage on my existing house personally, but it definitely made sense to me at six point a half, 7% to just pay it off.

Mindy:
Okay. Well I’m glad that you caveated all of that. Again, listeners, we want to hear from you and we want to hear what you’re doing and why. And even if just I don’t like debt is the reason. That’s a valid reason. Like I said, it’s personal finances, personals. Alright, Scott, I think we have shared both sides of our story. Is there anything else you’d like to add before we skedaddle?

Scott:
The only thing I want to add that I think that a lot of people can’t help themselves. Maybe I’m a part of this group and say, yeah, I know the stock market returned 10% ish on average compounding over the last 70 a hundred years, but really isn’t going to do that over the next 20 to 30 years. And if that’s in the back of your mind as well, that continues to be another little dial, a little extra oomph on the paying off the mortgage early argument there. Yeah,

Mindy:
Like I said, personal finance is personal, so make the decision based on something, not just, oh, Dave Ramsey told me that the paid off house is the new BMW or whatever his thing says. If you don’t identify with paying off your house, then don’t keep your mortgage. If you do, then take Scott’s side. I’ll still like you.

Scott:
I think in 2024 we say the paid off home is the new Rivian.

Mindy:
Ooh, the new Rivian. Daphne wants a rivian. She’s like, mom, when I turn 16, will you buy me one? I’m like, no. Alright. Just as a reminder, we have a website, biggerpockets.com where you can go to learn everything there is to know about real estate investing and we will see you there. Scott and I are in the forums frequently, so give us a shout out, give us a tag, and we will come in and have a conversation with you. Scott, should we get out of here?

Scott:
Let’s do

Mindy:
It. That wraps up this episode of the BiggerPockets Money Podcast. He of course is the Scott Trench, and I am Mindy Jensen saying, Bye-Bye. Dragon’s eye BiggerPockets money was created by Mindy Jensen and Scott Trench. This episode was produced by Eric Knutson, copywriting by Calico Content, post-production by Exodus Media and Chris Micen. Thanks for listening.