Home ownership is one of the cornerstones of achieving the American dream. Purchasing a home gives individuals and families to accumulate wealth through equity and appreciation over time. Traditionally, you’d purchase a home with a 30 year mortgage and pay it down over your working career so that you’d own your home outright by the time you retired and you had a roof over your head for your golden years.
If you’ve been following me, you probably know that all solid financial plans begin with a budget. If you’ve created a budget and left a chunk in there for savings/investment/debt repayment, the question begs to be asked – which one do you do first. You’d obviously want to pay off high interest debt before you invest. The average 30 year mortgage rate in the US last year was 3.3%. Stock market returns over the last 10 years, on the other hand, have been almost 14% a year. Add to the equation the growth in home prices and the equation becomes pretty heavily weighted towards investing in the stock market as opposed to putting money towards paying down your mortgage.
I’ve seen a lot of real estate investment YouTubers and podcasters scoff at the idea of paying off your mortgage completely. While they’re not mathematically wrong considering the recent past, I want to present a different, more philosophical perspective.
A philosophical perspective on wealth
If we think about every other species in the world, the needs are pretty basic. Primarily, three things.
Food and Water (or subsistence in general)
Protection (From the Elements & Predators)
Propagation of the Species
The population of any species that has these 3 things will thrive. All other species however, haven’t developed intellectual capabilities to yearn for anything beyond the basics. The hunt for these 3 things keeps them busy enough to worry about anything else.
As humans however, we’re far more evolved. The intelligence that makes us the apex predator also keeps us yearning for creature comforts beyond the basics. No matter how much we have, we always tend to want more. That brings us to the point I am trying to make. I believe that as humans, we tend to have a 4th basic need – Happiness
Simple enough, but in fact, couldn’t be more complex. We all want to be happy but most of us have no idea how. We rely on heavy marketing and social media to tell us what it is. The ultimate driving machine, a TV that is just a little slimmer or sharper or that pair of Jimmy Choo’s. We’re stuck in a rat race of temporary thrill from material things that is an addiction that has to be constantly fed. I guarantee you that your ability to see through marketing embellishment will be a huge determinant of you ultimately achieving financial success. More on that later.
Now back to the home payoff discussion –
A Vs. B – A Risk Reward Proposition
In today’s low mortgage rate environment, it is a no brainer that owning a home is better than renting. With some planning, saving and smart borrowing, you can become a home owner. However, once you do, should you start working on paying off that house or focus on investing to build more wealth? Putting money towards a mortgage that gives you guaranteed savings of around 3% in interest vs. investing in stocks/real estate that may bring 7-10% in potential non guaranteed returns. The primary difference here is that one is guaranteed and the other isn’t. It is precisely why the numbers are different too. Historically, real estate values have gone up and so have stocks and both by higher rates than mortgage interests so if the trend were to continue, and wealth building was your goal, you’d want to hold off on paying off your house.
YouTubers advise their followers to never pay off their house. Instead use the savings to buy more and more real estate and build wealth quickly. They aren’t entirely wrong in recommending purchasing real estate through financing in this low interest environment. Mathematically, it all makes sense. But I urge you ask yourself this. Are you going to feel happy owning 10 properties, none of which you truly own and could all go down in value if the real estate market was to crash and you’re stuck with paying mortgages for or even going bankrupt? Or would you feel happier knowing you have a place that is yours. One that no one can stake a claim to. One that you can come back to, lay your head on the pillow and sleep in peace knowing you will always have the shelter you need. Once you have that, you can go purchase more properties and create rental income all you want. If they go down in value, you still have your basic needs covered.
Below is a breakdown of what would happen if you invested an extra $500 a month in the stock market at 7% return vs. if you put the same money towards paying off a $450k home mortgage.
Given that your mortgage is likely to be paid off in 21 years, lets look at what would happen if you put the same money into stocks for 21 years.
As you can see, paying off your house will save you $84,327 over 21 year GUARANTEED, while investing in stocks would get you $153,292 in ESTIMATED returns over the same time. Once again, remember that one is guaranteed while the other is an estimate tied with some risk.
My Personal Choice (And a recommendation against conventional wisdom)
Personally, I decided to do the opposite of what the wisdom of numbers would suggest. I’ve had a history of living through some tumultuous times as a first generation immigrant who graduated just prior to The Great Recession and put tremendous value on having a guaranteed roof over your head and food on the table. My wife and I worked hard to pay off our Washington home before we turned 35. We’ve since moved into another home and turned the paid off home into a cash-flowing rental property. However, knowing that we have a place we can go back to, in case all financial hell rains down on us, provides an unparalleled level of mental peace. A couple of additional properties or a few hundred thousand dollars of additional net worth on paper cannot substitute for it. Am I poorer on paper for making this choice? Sure. Am I happier I made this choice that eliminates risk of financial catastrophe? You betcha.
Ultimately, we’re all products of our own life experiences and that is what makes us individuals. Conventional wisdom and analytical decision making invariably suggests that it is unwise to pay off your home early and invest in long term wealth building by investing those dollars. However, I implore you to put a value on peace of mind.