early payoff: the great mortgage debate

The New York Times published a brief article in Sunday's Real Estate section about the great payoff debate: does it really make sense to pay the mortgage off early?

The article notes that this isn't a simple yes-or-no question (duh) and that there are a great many factors that need to be taken into consideration. In the con camp, people who have been able to benefit from low fixed rates may well be better off investing their extra money in the stock market instead: despite the current turbulence, historic market returns are about 9% over twenty years. When you factor in the fact that tax benefits for mortgages reduce an effective interest rate of 6% to about 4% (give or take; depends on your tax bracket), that's even more of an incentive to forego the early payoff.

Having said that, there are also strong arguments in favor of paying off the mortgage early. People with artificially low "teaser" rates that come from having an adjustible-rate mortgage have a great incentive to make as much headway as possible before their rates start floating with the market: not knowing how much your payments will end up costing is pretty scary.

I'm not sure that many people with ARM's actually take that perspective, but that's how I look at it.

In addition, not having house payments means lower living expenses; that's a huge bonus in an uncertain job market. Having home equity also means having a potential line of credit in case of an emergency, though I tend to think that that should be among the pool of options to be exercised only as a last resort.

Looking at it more quantitatively, there's definitely opportunity cost from not investing extra money in the stock market. The resulting bleed can be mitigated somewhat by making the payoff period very short indeed - a few years as opposed to dragging out early payments for ten years or more.

If you've read any of this blog so far, you'll already know that I'm paying my mortgage off early: six years and ten months if I can stay on my present course. Even if the numbers don't fully work to my advantage, the peace of mind is priceless. I'm hedging my bets, though, and here's how I'm doing it:

• I have no debt other than my mortgage. If you have medical debt, student loans, or especially credit card debt, prepaying probably isn't for you: the interest rate on your mortgage is likely to be less than any other debt, so it makes sense to tackle the other debt first.


• My 401(k) is fully funded. So is my IRA. Those two investment vehicles are non-negotiable: if I have to reduce my mortgage prepayment to fund my retirement, I will.


• Before I started aggressively prepaying, I saved up enough money for a decent-sized mutual fund portfolio outside of retirement savings. I could sell it off and pay off my mortgage tomorrow, but I think the risks of becoming less financially diversified outweigh the benefit of cranking away at my current pace for another twenty months.


• I have a cash-based emergency fund, and that's been a tremendous benefit over the past few years. I've had to tap it more than I'd like for very good reasons: four major appliances died and had to be replaced (refrigerator, dishwasher, and two air conditioners), and I've had to make several unplanned cross-country flights with very short notice to respond to family emergencies. Having an emergency fund means that I was able to do this without incurring any debt or having to tap longer-term assets like my mutual funds. Having said that, my emergency fund is no longer as robust as I'd like it to be. As a result, I backed off on my mortgage prepayment a few months ago and am rerouting some of that money to rebuild my emergency fund.


• I have adequate health and dental insurance. As a result, I'm confident that an unexpected medical crisis won't significantly derail my savings plan. (I'm also really fit and healthy, though: again, I'm hedging my bets.) I have two minor immune system disorders that are controlled but require ongoing management; as a result, health insurance is not something I can afford to do without.


• I live simply and frugally, and I'm disciplined about my budget. Part of what keeps me on track is knowing that in twenty months, my financial life will gain significantly more flexibility.


• My job seems stable for at least a while. Even if it's not, the fact that I have broadly diversified assets and an emergency fund means that I can afford to be unemployed for a while without going bankrupt.

In short, while I think that paying off one's mortgage early is generally good, there needs to be a specific set of circumstances in place to make it the best decision in terms of one's overall financial well-being. I've worked hard to get to that place, but if I can do it, anyone can.

Outright home ownership brings peace of mind like nothing else.

What's it worth to you?