Most people have one mortgage, the rich have two.
I get asked the question often: “I have extra cash, should I put it toward paying down my mortgage?”
The short answer is sure, but no. Confused? Don’t be. The answer inevitably lies with your goals and feelings about money.
Typically, we steer clear from emotions when making a financial plan but some decisions can be made with your peace of mind at the forefront of your decisions making. One of those financial forks in the road is where to put extra cash within your portfolio.
Should you put “extra” money towards paying down your mortgage? There are two main avenues to consider when making this decision. First, does it make fiscal sense? That answer depends on a few factors:
- What is your current interest rate? If you have a low rate mortgage, as most people do right now, you are paying around 4% interest or less.
- Do you have additional debt with higher interest rates? These should be paid down first.
- How much time do you have? Are you nearing retirement? Still 20-30 years from the end of your career? This makes a difference.
- Do you have an emergency savings fund established and funded should you need to change jobs, move, etc.?
- Are you saving for retirement, education and other goals?
If you have a low interest mortgage, no debt with higher interest rates, are still far from retirement age, have an emergency fund and retirement savings, then you truly have extra cash. Congratulations! This is where the quote above, “most people have one mortgage, the rich have two” comes into play. Financial stability allows for the freedom of borrowing at a lower interest rate in order to invest at a higher rate of return.
Let’s start by looking at some crude numbers to demonstrate the financial ramifications of real estate investment (in your home) vs. market investment:
- A house bought outright in 1995 for $73k and sold in 2015 for $460k made 6.3x return.
- In that same 20-year time, $1k invested in the stock market in 1995 yielded a 6.5x return.
A slight difference, until you factor in that the house cost money to maintain. There were taxes to pay, insurance, and upkeep. So was it really a 6.3x return? Very likely, not. Whereas, the money in the stock market just sat there, ignored for years and still managed to make 6.5x return.
So the long-term math argument to invest in the market vs. paying down your mortgage is sound. That’s not to say it is the right decision. Here are a few reasons why paying down your mortgage could be an excellent choice for you:
- If you pay down your mortgage, you get a guaranteed return (whatever the rate of interest you are paying).
- You have flexibility. You can stop and start extra payments anytime you want (instead of waiting to pull cash out of brokerage accounts).
- It feels good. This one can’t be discounted. A lot of people sleep better at night knowing their money is going into something they eat, sleep and live in day-to-day.
What you choose to do with extra money is completely up to you, just don’t hold it in cash. Make your money work for you.
00:00 Matt: Welcome to real financial planning WKXL is available wherever get your podcasts. I'm Matt Robinson joined as always by Mike Morton, the owner of Morton financial advice, the host of financial planning for entrepreneurs, the temporarily named podcast, the Mike podcast that is always in search of a better name. I think we should just this our white whale quest someday. We will remember. Mike Wharton's podcast. You know what, if you've got ideas for what rename the Mike Morton's podcast and like real ideas, like not
00:31 Mike: White whale ideas?.
00:32 Matt: For initials, or our IP the last name is free. I don't want suggestions like that. White whale. There you go. I don't want suggestions like that. If you have suggestions, you can email, where can people email you?
00:43 Mike: .
00:46 Matt: Or you can post serious suggestions on the beyond politics with Paul Hodes and Matt Robinson, Facebook page, by the way, that email and that Facebook is also where we get some really good listener questions. And we've got a good one this week from someone. With a lot of money lying around now. I don't. Yeah, I'm not, I'm not dissing our listeners who submit questions. I'm envious. I wish I had a lot of extra money lying around. I don't, but this person had a question. Should I put extra money toward my mortgage? Mike Morton, this person. Put extra toward paying down their mortgage.
01:28 Mike: It's funny, man. I get this question from quite a few clients and it's not necessarily like extra money. We all wish we, found some thousands of dollars in the couch cushions. We get this question that, Hey, you know, out of my cash flow, I'm already, doing some savings for retirement or education, college savings. And there are a of articles online that are recommending paying down your mortgage. you know You can easily find articles that say, if you add just one payment a year, either spreading it out one 12th of your payment each month or just at the end of the ear, throw in one more, the extra payment you can, really the number of years on your 30-year mortgage, maybe down to 27, 25 years just by making that one payment and saving on all that interest. So there are a lot of articles encouraging that. the question comes up a lot. Should I make extra payment towards my mortgage? Like Anything else? is not financial advice, even though the YPN that the title of the podcast.
02:25 Matt: What is it then?
02:27 Mike: is not personal advice, but here are some ideas to consider
02:31 Matt: Yeah it's like Ms. Cleo. It's for entertainment only. I'm not telling you your future, But except she went to federal prison. That's not gonna happen to you. I don't think actually, let me hear what you have to say first.
02:43 Mike: Exactly. So like everything It all depends, Matt. There's a variety of factors that come into play here, but I will start with this generally. I'm not the biggest fan of this. I'm not the biggest fan of putting extra money towards your mortgage. And there are a few reasons why, of course we'll get into it but the biggest would be well justified in the past few years mortgage rates have been extremely low. Many of my clients have refinanced a couple of times as mortgage rates came down over the last five years, and now they're sitting on right aeound 3% mortgage rate. And at that kind of rate, it's probably a pretty good idea to just borrow that amount of money and make the required. payments but not make payments. So generally I'm not a fan of making extra payments towards your mortgage.
03:31 Matt: Got it. So why, why would you do that? Besides the fact that this thing is hanging over your head, I mean I hate it. I hate having that hanging over one's head. I hate the student loan thing over without complaining. Right But I just don't like, look, I didn't like Cause I didn't like homework. I didn't like things hanging over my head. I'm an inbox kind of guy. I got to this. That's the way I organize everything. I was late joining you because I was going through mine. list. And I was like, look, got this in my inbox. I'm going to take care of it. I'm going to send it out of my outbox. That's the way I operate. I just hate having huge debts hanging over me. Not that anyone loves that. And what's also super depressing is if you look at your mortgage. and you look at your projected payments, you can do this with your student loans. As well, but I suggest that you make some homemade Prozac first, which is just gin and ice cream because it's depressing how much total money you're going to pay because you accrue all this interest. You're not even when you pay down more. 80% of your payment is going toward interest at first, and very little is going toward actually paying down the principal. So I do see the logic, of the faster you get into paying down that principle, the less of that interest or you're accruing, that does feel good. So is that the argument for that?
04:51 Mike: Well, there are a few arguments for doing so but I like what you brought up there in terms of the way that it makes you feel. And I know many examples where even financial advisors, financial planners, people that understand the ins and outs of the. Still, pay off their mortgage because they feel great they made the last payment and they say I know the math wasn't in my favor, but I just feel good. This was one of the best money decisions I made. So for those that do not like these years. Gosh, 80% of this goes towards interest. I want to get ahead here. I do not want to be paying this off when I'm 70, that. The sleep at night factor, the feeling great factor, really trumps a lot of other things in my opinion. And that's what I say to clients and friends all the time: if it's going to make you feel really good, then go for it. There are a lot of downsides to adding extra. To your mortgage. So if it's going to make you feel great by paying that off, there are many examples where people went through that and yes, it did make me feel great. And so I have pretty high confidence that if you're on that track, keep going that way, go ahead and keep paying it down, get it paid off so that the sleep at night, the feeling good is gonna work.
06:09 Matt: There is a math argument that, and we've gone through this before when we talked about. The topic of how rich people. of their money tied up in investments and market and equity in companies, whatever it is like. Jeff Bezos. You don't w what was Simpson's line like about there? Arnold Schwartzenegger knockoff. It's like someone asked him, how do you sleep at night? And he says on a pile of money with many beautiful ladies. So it felt like Jeff Bezos sleeps at night on a literal pile of money. Like all of his money is tied up. So how does it work? Borrows money at a certain rate and then his investments earn more than that. And so it pays off, pays him money to borrow as insane as that sounds. As had pointed out in a previous episode actually the rest of us can tdo his as well. If you're invested and your rate of return is higher than borrowing. So I guess there is, there's the argument for letting your mortgage just spool along is that there is an arbitrage use a big word there to be therefore of if you're earning more in the market, you're better off keeping your money in the market and paying the interest on the other hand, on your remaining loans, because you're earning more than yours. Building up in interest costs, but dang that's, I don't know. It feels fraught. Is that so that's the idea that people generally argue is Nah, don't do it because as a math matter, you're coming out ahead.
07:53 Mike: That's exactly right. So most people have one mortgage and the rich are heavy. Or more. Okay. And to exactly your point, that's true because when you can take the longer view, you're exactly right. If I can borrow 3%, which is my mortgage, maybe we can talk about rates going up there currently around 5%. And that does change the math. Okay. But if you could borrow it three or 4% and the long-term historical average of the stock markets, eight, nine, 10%. That's a no-brainer right now. The downside, of course, is that it is long-term. So if you can take a long-term view 10, 20, 30 years and invest that thousand dollars versus it towards your mortgage, then you're pretty, I think pretty likely to come out ahead taking a long-term historical view of the stock market eight, nine, 10% versus it only cost you 3% to borrow it. So the lower your mortgage. The more confident you might be. And investing that money for the So there's a couple of comments One, why can the rich do this more easily? Because they have more cushion. They have more available. They've already got their emergency savings. They know they have plenty of Whereas the rest of us are still building up emergency savings, and retirement. savings College savings. And so we can't necessarily be as risky or take that five years the stock market might go down or flat for five years, will you stay invested? Can you ride it out? Those are the kinds of questions you got to think ahead of. And is what we said. Earlier Hey, paying down your mortgage feels good because it's locked in, it's getting done. And so that feels good to have that safety and security, but in terms of pure math, that's exactly the way it works, Matt. If can get a higher return over some time than what your borrowing costs are, then of course,
09:46 Matt: It's a really good point. You raise Well it's really good it's sort of like well compared to what if you have the ability to add another mortgage not using you're not using. in a vacuum. Right, So it's like whatever your mortgage payment is I don't know, let's just say it's just to have a number. So you have 2000 bucks available. What are the other things you could do? What are the others you brought up with that? And then you brought up one which is well do you have enough emergency savings? Do you have enough in your hand to handle an unexpected expense? What about, I mean here's a What about I mean's a question you've said this on the show before giving a lot of really insightful financial advice. This is one you could get if you have credit cards? what if you have credit cards right That said a much higher right much higher should pay that off first, right? I mean should pay that off first right I there kind is there kind of a checklist you should go through first before you consider this,
10:48 Mike: Oh, yeah, there's a checklist. So we have done an episode, Matt, on that account funding priority. And you pay down your credit card, debt first, any high-interest debt . And so let's talk about it in this way. So it's not a vacuum. right So your mortgage might be three or 4%, maybe 5% might more. Your credit card debt might be 12%. Your student loan debt might be six, seven, or 8%. Okay. And so if I'm thinking about a student loan at 8%, okay. If I pay some of that off, I take a thousand dollars and put it towards that student debt. I'm getting a guaranteed 8% return. Cause I'm going to either pay the 8% if I ride for another year I'm going to pay it off and save myself that 8% interest. And so that's the way you want to think about your mortgage. If you have a mortgage and you put an extra thousand dollars towards it, you get a guaranteed 4% return that thousand dollars, which is pretty good, like a guaranteed return. So in other words, here's the. point don't if you're going to not pay towards the mortgage and have some extra money, 500 bucks a month, instead of you say ah, listen to your episode. You're right. I'm going to stop making an extra $500 payment, toward my mortgage. Don't just leave the $500 in your checking or savings account making almost nothing. Because you were saving three, 4% every time you paid that off. Okay. So you can't just let it build up cash either because you're not going to get that long-term return and get, mathematically, come out ahead in 20 years
12:24 Matt: Look since you introduced I think we should go there And I think we should go there. And this is you know you can. where you know you can now. if you're the kind of podcast here and do not want to hear any numbers, It's because we're so entertaining and we aren't so entertaining and we don't just talk about you could fast forward for one could fast forward for like one minute here, but you had a little example. I thought that was just a really interesting comparison that, that You had worked up about well what is at well, what is it? What's an investment payoff Versus an investment Versus the stock market. Interesting So if you don't want to hear this So if you don't want to hear this fast forward,
13:07 Mike: You want to hear ?
13:07 Matt: All right here…
13:08 Mike: You definitely want to hear this because the numbers are really simple. And I get this a lot, Matt. So I thought I'd throw in this episode, to be honest upfront here, it's not an exact comparison to what we're talking I'm not comparing. Putting a thousand against your mortgage versus putting a thousand in the stock market. What's the potential return that has a borrowing cost? And I don't
13:27 Matt: It's illustrative.
13:28 Mike: Mortgage
13:29 Matt: It's illustrative.
13:30 Mike: To tell you this. This is an example of, let's say we buy a house in 1995 for $73,000 20 years later in 2015, we sell it for $460,000. Everyone's heard this story, right? Oh yeah. I can't believe you got that house for 75,000 bucks. worth like half a million now. That's fantastic. That's about six, almost six and a half times. Your money, 6.3 times your money. So you paid for the house just outright. You didn't get any mortgage and then you sold it 20 years later and you got 6.3 times your money, which is amazing. Instead, I looked up the stock market during that same time. Okay. And if you put money in the stock market in 1995 and then sold it in 2015, you would have gotten 6.5 times your money
14:19 Matt: Slightly slightly higher
14:21 Mike: Slightly higher and oh, by the way, Matt, houses cost money, maybe some upkeep property taxes, right? Those kinds of things. Whereas the stock market, you just put some money in there and you don't think about it whatsoever. So that's the funny thing about it. The way our minds work that you hear all these great stories about, I can't believe the house was so cheap I can't believe how much they're worth now. But you skip over 20 years, 30 years. And the stock market also chugs along really nicely during those times. So that's just illustrating that instead of making those extra payments towards your house, you can put it in the stock market. If you get that 20, 30 year…
14:57 Matt: So that
14:58 Mike: Uh you can be doing
14:59 Matt: Sort of the the mental threshold check yourself on the way you're yourself on the way might be thinking about You might be thinking know some kind of you know some kind of a paying proposition, a payoff you just have to remember and you just have to remember what the historic returns are in the again it's a matter And again it's a matter of it does. Oh, go. does
15:22 Mike: Yeah. Yeah. Let me, yeah, let me pause you on that too, because lots of people have that and these examples illustrate that housing typically is not as
15:32 Matt: You've said on this show before don't even treat your house like an investment anyway.
15:39 Mike: Yeah there's that your house, I'm just saying even as an investment, oh, I could take $10,000 and invest it in some property or I invest it in the stock market. Now in general, when we're talking about portfolios, I like a little bit of both of those okay. Types of investments, but real estate doesn't do quite as well. As pure kind companies. So just you think about that as well and know that Hey investing in companies, I had the potential for a little higher return over long
16:08 Matt: well and look if you are sitting around and well, and look, if you are sitting around and trying to project here's 2000 bucks, what am I here are 2000 bucks what am I know what what's the where am I going to get like the, best return am I going to get, like the best return on this? Is it paying off? Is a factor in there if Mike sits around and does the math or is a factor in their bearing is a factor in their bearing in mind that there is a mortgage on your taxes. There's a student loan your deduction on your taxes So what you you're accruing and interest, you are accruing in accruing interest, you are accruing interest but there's a little bit of a clawback on that right
16:50 Mike: Yeah, that's again, that's why most of us have one mortgage. Because you have all deductions and depreciation. And when I was just really mad, it got very complicated. So I don't recommend, really trying to get into the details of that, unless you're at a certain wealth that it's like, Hey, we're investing thousands of dollars in these different areas and what are deductions. And this is where I mentioned real estate. Doesn't typically appreciate as well as the stock. However, everyone's got stories of people they know that invest in real estate, right? Single-family homes, and apartment buildings, where you can get wealthy through property investing. And that's absolutely the case. And that has a lot to do with depreciation, interest, all kinds of things, but also recognize that people put in a ton of effort and work. So it's not just oh, they just invested $5,000 and check a few years, like your 401k. They're putting in tons of work. And I do recommend if you're interested in that that is fantastic of building wealth, but that's not really
17:51 Matt: I think that brings everything Well I think And maybe we should wrap a circle And maybe we should wrap on this it matters. What by saying it matters What makes you feel best? savings that's what your savings are what retirement savings that are what your savings are for is to feel confident and secure and good So ultimately the math on this So ultimately the does come down to what gives you that piece of down to what gives you that piece of
18:18 Mike: Yeah. And there are a few other points just to throw in there, you're thinking of trade-offs and flexibility, you can add more to the payments and then stop. And that's always: keep a 30-year rather than going to a year or 15-year mortgage, because you can always add more money. And if at some point in the future you can't or don't want to, you can always stop the extra payments. That's good. I do like it in terms of force. savings So sometimes having, taking more pain, more towards your mortgage, or even reducing the number years to 20 years or 15 years, and you have to pay more means you're forced to live on whatever's leftover. So that can be a really real mechanism there are some pros and cons to the different approaches, but it's just
18:57 Matt: Great advice as always Mike Great advice as always Mike Morton. Morton Thanks so much.
19:04 Mike: Thanks, for that
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