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I therefore believe it is my duty to my country to love it; to support its constitution; to obey its laws; to respect its flag; and to defend it against all enemies.

A Follow-up to the Dave Ramsey Mortgage Post – This is Interesting!

By JLP | March 8, 2007

Chris, an employee of Dave Ramsey and a blogger at Pour Out, left this comment on yesterday’s Dave Ramsey post about mortgages (I truncated Chris’ comment in order to emphasize what I want to talk about):

He [Dave] doesn’t want you to pay off your home in 15 years; He wants you to pay it off in 12 years, or 10 or 7 or 4!!! Add those extra years of investing the \$1700 house payment monthly and it’s probably a different picture. Digest the entire plan, not just bits and pieces, and you’ll end up ahead of the family in that right column. Good conversation you have going on here.

What would happen if you paid off a 15-year mortgage in 4 years? Would that change things? Let’s see…

In order to do this little calculation, I had to make some assumptions:

1. Taxes are ignored. There’s too many tax brackets and too many different scenarios. So, I decided to ignore taxes on both investments and the deductibility of interest.

2. I used the interest rates of 6.08% for the 15-year mortgage and 6.30% for the 30-year mortgage from yesterday’s post.

3. To pay off a \$200,000 mortgage in 4 years, it would require an additional payment to be made of \$3,000 per month, bringing the total monthly payment for the 15-year mortgage to \$4,696 . The monthly payment for the 30-year mortgage would be \$1,238.

4. I assumed that both families had an extra \$3,000 per month. The family with the 30-year note is investing their \$3,000 per month and getting an average return of 8% per year (or .67% per month).

5. After the 4 years is up, the family that paid off their mortgage early invests their entire payment of \$4,696 per month and also gets an 8% annual rate of return.

Here’s what I came up with:

This all boils down to the fact that we have to make choices as to where we allocate our money. These choices involve picking one “return” for another. If you choose to pay an extra \$3,000 per month on your house note so that you can be mortgage free in four years, then you also are making the choice NOT to invest the money elsewhere. This kind of thinking requires you to look at your personal finances like a business owner looks at their business.

57 Responses to “A Follow-up to the Dave Ramsey Mortgage Post – This is Interesting!”

1. traineeinvestor Says:
March 8th, 2007 at 7:40 pm

I looked at this issue some years ago (using 5% as my interest rate and 8% as my ROI) and reached the conclusion that I was better off not making early repayments so long as I have a sufficiently long time horizon to work with. The long time horizon is necessary to avoid the investments being caught on the wrong side of below average market returns.

Of course, if I take this logic to its ultimate conclusion I should opt for the largest interest only loan I could get and never pay it off – not even in retirement. Somehow I cannot quite bring myself to do that.

2. thc Says:
March 8th, 2007 at 8:59 pm

Mortgage money is cheap and the interest is tax-deductible. My marginal federal rate is 33% and CA is 9.3%. I’m gonna borrow as much as I can for as long as I can and invest for long-term gains and qualified dividends taxed at 15%. What doesn’t Dave Ramsey understand about this?

3. philskaren Says:
March 8th, 2007 at 9:53 pm

But, what if you invested the normal mortgage payment after the 4 years. You would surpass the 30 yr mortgage column, right?

4. TFB Says:
March 8th, 2007 at 10:41 pm

I don’t know if I mentioned this in previous comments before, but have you thought about this from the lender’s perspective? Why do they lend you at this low rate when they can also invest it for higher return themselves? They don’t know how to run a spreadsheet?

5. Chris Thomas Says:
March 8th, 2007 at 11:19 pm

Interesting. A question: What’s the total cost of the loan for Fam A if they pay it off in 4 years? How does it compare the the total cost for Fam B stretching for the full 30? Does this affect the bottom lines and if so, how much? JLP, I’m an advertising guy, so sometimes the math gets ahead of me, no doubt. My personal plan just feels right to me, so that’s where I’m sticking. You and your readers seem like the type of people who would be both diligent and disciplined, so if your plan/s is/are working well for you, I’m not going to argue. I would love to follow these two average families in real life though, without calculators, and just see which one ends up ahead in the end.

Thanks for the link BTW. I’m going to sleep. Getting on a plane for San Antonio tomorrow. If anyone lives in the SA area and would like a couple of tickets to Dave’s live event on Saturday, hit me up on the CrackBerry and I’ll see what I can do. Contact info available over at my blog.

6. thc Says:
March 8th, 2007 at 11:19 pm

TBF: Lenders may be able to invest for higher returns but not without taking on more risk. Their loans are fully collateralized–nothing safer.

7. plonkee Says:
March 9th, 2007 at 3:05 am

Effectively what you are doing if you are paying off your mortgage earlier is investing the money with the rate of return being the interest rate on the mortgage.

If over your time-frame you are confident that the stock market will have a better rate of return overall than your mortgage rate you will always be better off financially to pay the minimum on the mortgage and invest the rest in the stock market.

The total cost of the loan will be less if you pay the mortgage off earlier, but the investment opportunity cost will be greater. By this I mean the missed opportunity to make money by investing.

The other variable is the risk of investing in the stock market, which is why you need a long time frame, and is also why having an interest only mortgage is distinctly more risky. With an interest only mortgage, there is a chance (however small) that you will not have made enough money in investments to pay the principal at the end of the term.

8. Customers Revenge Says:
March 9th, 2007 at 5:49 am

I read the last few mortgage posts and some folks are just getting lost in the math. It’s hard to calculate everything exactly but the principle is this:

Money paid to the mortgage “earns” 6% (mort. interest).
Money diverted from paying the mortgage to earn 8% is equivalent to taking out a loan at 6% to invest in an 8% project; you are making 2% for every dollar you divert.

It does not matter what the time frames are or how much bigger the numbers look later. When you crunch it, you made an extra 2% on the money you diverted and there is no way to catch up with the same total payment.

Second: Not sure why the taxes are removed from the analysis because taxes are key. Mortage interest is paid with before-tax dollars meanwhile investments made with regular income are after tax — that is gigantic. It’s a 25% or more difference in the investment amount that cannot be ignored.

9. FMF Says:
March 9th, 2007 at 7:09 am

Here’s the rub:

While it makes sense logically and by the numbers to NOT pay off your house and instead invest the money, it’s not a practical solution.

Yeah, yeah, people can argue that they’ll take the money and invest it, but I’ve NEVER seen anyone actually consistently follow through with the plan. They may do it for a year or two, but eventually things come up, they make some changes and they SPEND the money they had meant to invest. Now they have their full mortgage and no investments.

Re-run your calculations using this scenario and see which is a better option.

10. Miguel Says:
March 9th, 2007 at 8:14 am

@ Customer’s Revenge – Unfortunately, it’s not that simple. Mortgage interest is only partially paid from pre-tax dollars. Deductability depends on your tax bracket, and a host of other variables. I’m no tax expert, but I know it varies greatly from individual to individual. Secondly, the stock market returns can high extremely volatile in the short-run, and even over a period of years. It’s not without some risk. Also, some investments can be made with before-tax dollars (ex. 401K, IRA, etc.), but again, these options vary greatly from individual to individual. Secondly, you cannot rule out the risks associated with carrying any significant level of debt – there is a risk to carrying debt too, and there could be consequences if things go way wrong. My only point is that the reason we’ve spent the past two days debating this topic is cause IT AIN’T SIMPLE and you can’t boil it down to a couple of sentences.

@FMF – That was the point I was trying to make a couple days ago and I still think that this concept of maxing the mortgage to invest the rest, would be ill-advised for 99% of the population – I know what would happen in reality. But, as JLP pointed out, that shouldn’t keep us PF-heads from considering it.

11. JLP Says:
March 9th, 2007 at 8:24 am

Adding taxes to this issue really complicates matters (as Miguel said). I can boil it down to this:

1. Mortgage interest on your home is deductible.
2. Some of the “savings” can be invested pre-tax in IRAs and company retirement plans.
3. The rest of the money could be invested in a low-cost index fund or annuity (from Vanguard). Yes, you will have to pay taxes along the way on money invested in an index. The money inside the annuity will grow tax-deferred and you’ll pay taxes on it when you retire.

All said, I think the 30-year mortgage offers better tax benefits.

12. JLP Says:
March 9th, 2007 at 8:34 am

FMF,

Who’s to say that someone who takes out a 15-year mortgage won’t run into financial problems? After all, the 15-year mortgage will cost them \$458 more per month.

My whole goal with all of this has been to address this issue PURELY from the math. To lay it all out there and let people decide for themselves. I think it is silly for Ramsey to post a poll asking people “which mortgage is the best option” with no further explanation. From what I have calculated, the 15-year mortgage is NOT the best option.

Finally, why do we expect people to keep their emotions in check when it comes to investing but encourage them to turn a rational decision like picking a mortgage strategy into an emotional issue?

13. Morgan Goeller Says:
March 9th, 2007 at 8:41 am

JFM — these assumptions don’t quite tell the entire story.

1. There is probably 25% of the population who think they are smarter, wiser, and more disciplined than 99% of the population. The problem is, most of them don’t learn the truth until it is too late. Finance is at least as much behavior as it is math, and this is ignored in the model.

As I said before, casinos make a lot more money off of the people who think they can count cards than they lose from the people who actually can.

2. The Ramsey plan recommends to put 15% of your income into retirement savings AND fully funding your children’s college education before starting to pay off the mortgage early. Very, very few people can afford to do this in addition to paying off a \$225K mortgage in 4 years.

I don’t believe this is comparing apples to apples when looking at your numbers.

3. These calculations ignore risk completely. Someone paying off their mortgage early is going to have a lot less risk than someone paying for 30 years with normal consumption.

A question to ask yourself is, “If my house were completely paid off, would I take out a mortgage to invest in the stock market?” If the answer isn’t an immediate yes, then there is something more to this in your own mind than just crunching the numbers.

This is how your mind percieves risk, and it is a good thing to consider. How much risk do you actually want to take with your families future? Will a spreadsheet forcasting a few extra thousand dollars be any consolation if you are facing forclosure?

A challenge:

I will be happy to concede my point if anyone who is arguing for a longer mortgage will refinance their current 30-year mortgage for either a 40-year, 50-year, or interest only loan. By this model, the numbers are even better for a longer term, so you are leaving money on the table.

You can send me a copy of the paperwork, dated after 3/9/2007. Put your money where your mouth is

14. JLP Says:
March 9th, 2007 at 8:58 am

Morgan,

Risk:

I’m actually advocating diversification. I mean, isn’t it risky to put all your financial eggs in one basket (your house)? What happens if the local plant closes and property values fall through the floor? It could happen.

Seriously, paying down your mortgage quickly is not much different from allocating money into fixed income investments.

15. prodyssey Says:
March 9th, 2007 at 9:18 am

Although someone else may have already mentioned this, I think the bit Morgan mentioned in his post about “…how your mind perceives risk” is on the money. In any of the comparisons, certain assumptions must be made. Some are more certain (term of the mortgage loan, interest rate on said loan) while others are quite a bit more subjective (anticipated return on investments, future financial picture of the individual).

It is the uncertainty / subjetivity that drives the debate. If the inputs were certain, then the outcome could be more or less certain…and the comparison simple. Generally, do you feel more comfortable with the “bird in hand” (certainty of mortgage) or are you confident there must be “two in the bush”(potential higher returns from alternative investments)…and that you can catch them!!??

For myself, I generally subscribe to the earlier points about mortgages being the cheapest money available with all the requisite benefits of tax deductions, etc. I also believe that generally, the stock market will post a better return than what I can receive by paying off my mortage earlier.

HOWEVER, what is my level of conviction? I’d say I’m middle of the road. I have a 15-year mortgage @ 4.75%, but generally invest whatever is left in equities. So, I think the alternative investment is a smart one, but I also like to hedge my risk with a shorter mortgage at a good rate.

A quick disclosure: Currently, I do have a significant amount of cash (>\$100K), but that’s only because we are looking to build a new house. And yes, I hate the prospect of giving up my existing 4.75% mortgage as I doubt I will ever see it again.

16. Morgan Goeller Says:
March 9th, 2007 at 9:20 am

JLP –

Good point about diversification. After paying off all your debt, putting 15% into the market (IRA/Roth/401K) and creating a college fund (10% perhaps, still in the market in a 529 or Coverdell) then I would say that the house is a reasonably good hedge.

Also, if we have a ‘local plant closing’, wouldn’t you rather have a paid off house at that point? If I were laid off, I would rather worry about paying property taxes than in having to pay off principal, interest, and property taxes for the next 40 years.

I would argue that having a mortgage and putting money in the market is no different than borrowing against a paid for house to invest, other than taxes. That sounds more complicated and riskier, needlessly so.

BTW, when I first attended FPU I was skeptical, largely for mathematical reasons (I was a Math major in college). However, after attending the course and looking at the entire picture (the numbers + human behavior) my eyes were opened.

You might want to consider reading one of his books (or attending FPU) so you are a bit more informed about the entire plan. I have an extra copy of Financial Peace Revisited and would be happy to send it to you, on my dime. Clearly you are a sharp cookie and I would be interested in your opinion after taking a look at the entire picture.

17. maxconfus Says:
March 9th, 2007 at 9:27 am

Mortgage interest is deductible.

I don’t know about you but I am paying down my mortgage early. I really don’t see mortgage interest as a deductible as a selling point to keep a long mortgage. Besides if someone wants a good tax deduction then they can buy rental real estate.

18. Jesse Says:
March 9th, 2007 at 9:30 am

I’d still like to see someone take on that challenge.

I don’t think we should be talking about making a decision until we realize that these types of decisions have two components:

Math + Everything Else

The math is easy enough for a spreadsheet to handle, but the Everything Else part is where it breaks down. JLP’s right in isolating it purely mathematically, and I believe he’s right in also saying that the Math should be considered, but that it’s not the only part of the equation.

We all agree that mathematically this is correct. With Everything Else, you’ll have a whole bunch of different answers.

19. LivingAlmostLarge Says:
March 9th, 2007 at 9:46 am

There is a man who does refinance his houses and keeps a mortgage at 67. Go to http://www.msn.com message boards and call out for Phil 5185. He have over a 3 million NW and has owned rentals since the 70s. He refinances his rentals and his primary mortgage to 80% with a 30 year fixed and invests in the stock market. He earns about 12% in index funds. He’ll tell you that if you ask rich people who invest in RE long term (not flippers, and not people doing it these last 5 years), that making money on RE by doing this is wise. Why? Diversification instead of keeping it all in RE.

Second, I have to defend this post because who can afford to pay \$4k above a mortage of \$1200? That means you have to be making at least \$2200 + \$4k (net, or at least \$8k gross/month). That is \$96k/year. Now with the median income \$48k/family annually, I’d like to know where these people are getting an extra \$4k/month to pay off their mortgage. All you DR follower’s let’s not forget that if you are paying off the mortgage and saving 15% to retirement and 10% to college then 25% of your income is gone, so the presumed family needs to be earning \$10k/month gross. Um, less than 5% of the population earns \$120k/year so the hypothetical isn’t jivving.

Now let’s talk reality DR followers. Reality is not many people make \$260k/year to max out 2 401k and 2 IRAs (nondeductible obviously). You need to make \$153k/year gross to max out 1 401k, 2 Roth IRAs! How many people here make that much? Well if you aren’t making that much (and less than 5% of the population is), then you are losing money.

How? Well if you invested in 401k or IRA before paying off the mortgage and maxed it out, you are getting a huge tax break. More than a 6% mortgage, immediately 10-15% federally and say 5% state! So you are investing with less money. And the money grow tax free!

So if you are paying off your mortgage with after tax dollars of \$4k/month you will go above and beyond your allotted \$39k/couple/per year into 401k/IRAs. And you will be investing into a taxable account which will throw off dividends and interest. So your actual rate of return is lower.

I love the fact that people who follow DR hate this logic. It’s supported by math and common sense. Never can they argue that they are maxing out all retirement account with 15%. Nor can they argue about the immediate tax break and the great bonus of not-taxing the gains in a retirement account. These are reasons I’ll keep my mortgage and max out all retirement first. Then I’ll consider paying off my mortgage depending on what other options I have.

Also the mortgage deduction to me personally is icing on the cake, but not the cake reason to keep the mortgage. The cake reason is I’ll have more money that you will because I’ll have maxed out my retirement accounts and allowed them to compound longer tax free. Please explain the logic/math how you will overcome a 401k/IRA maxed out by prepaying a 15 year mortgage? And catch up to me?

20. LivingAlmostLarge Says:
March 9th, 2007 at 9:50 am

Oh and Morgan Gellar, if you were a math major in college going to DR you had debt. I have to point out you probably were not good with money for being a math major. Which is a pretty big deal when you can see spending more on CC than you can pay = interest.

Even without math degrees and barely speaking english it didn’t take my parents very much time (none actually) that buying something you can’t pay cash for on CC is stupid. Buying it on a CC when you can pay cash it doesn’t matter.

21. tinyhands Says:
March 9th, 2007 at 10:00 am

I don’t see anything wrong with the numbers here. Any arguments against are either based on conjecture or emotion. Well, what if this or what if that? The kind of people who do this…

22. TFB Says:
March 9th, 2007 at 10:38 am

I mean, isn’t it risky to put all your financial eggs in one basket (your house)? What happens if the local plant closes and property values fall through the floor? It could happen.

Your house doesn’t know you have a mortgage. If the real estate value falls by 15%, your loss is 15% of the house’s value. It has little to do with how much equity you have, whether it’s 20%, 50%, or 100%, assuming we are talking about traditional 20% down type of mortgages, not 0 down interest only types. Paying down mortgage is not the same as investing in real estate. The real estate investment decision was already made when you bought the house.

These debates go to both extremes. If paying down is better, one should pay down as fast as possible, in 4 years, how about 2 years, or just buy the house with cash. If stretching is better, one should get a 50-year interest only loan. That’s how math works. Given a set of agreed upon inputs and assumptions, there could be one and only one correct answer. Real life is much more than math. If you find yourself on one extreme or another, go to the middle a little bit.

23. Gaming The Credit System Says:
March 9th, 2007 at 10:42 am

philskaren: read point #5 in the original post.

jlp: When I saw the title “This is Interesting!” I thought that maybe it would come out the opposite way due to some strange interplay with the interest or something. But I guess not

I’m actually coming at this from the point of view that you mention, that of a business owner. I actually don’t own any real estate right now, and I won’t own a home to live in for quite some time. (In a nutshell: Tax issues make it beneficial for me to “live” at my parents’ house in another area while I rent in the area where I work.) But I am big on investing in real estate. I am getting ready to do my first deal in the next couple of months. I want any investment property to be cashflow positive from the get-go, and that’s not so hard around here…. as long as you stick with the 30-year mortgage.

…Oh crap, I just realized that I forgot to submit this comment last night! Anyway, maybe that’s a good thing, because last night I also realized something new that may shed a new light on the subject: this is an issue of security vs. freedom. These are two goals that everybody wants generally, but there’s usually a trade-off between the two. We are all familiar with this debate with regard to being frisked at the airport, etc. But this “pay off your mortgage early vs. save the money elsewhere” debate is the same thing. Paying off your mortgage early = security. Taking that money and investing it = freedom. Which of the two do you prefer? Can you trust yourself with a large degree of freedom, or do you need to be locked in to something more secure and inflexible?

24. plonkee Says:
March 9th, 2007 at 11:17 am

I was thinking that if the local economy suffered and the housing market went through the floor there might be a greater chance of you losing your job and needing to sell the house to move to a new area.

25. Miguel Says:
March 9th, 2007 at 1:21 pm

Again, most of the above comments reinforce my opinion that the real answer to this riddle is: IT DEPENDS. That’s not wishy-washy, it’s just being practical and realistic.

Carrying a sizable mortgage and investing the rest work nicely for me because:

1) I’m in a high tax bracket and subject to AMT.
2) I already have substantial liquid, non-retirement funds, which create a significant cushion against risks (and could be used to pay off the mortgage).
3) Loan-to-Value on my home is only about 35% (i.e. 65% equity), so again risk of devaluation below the debt is pretty low.
4) very disciplined when it comes to budgeting and investing.
5) Have numerous business and invmt opptys that would require capital investment, and could generate returns substantially in exess of funding costs.
6) Mortgage interest rate is very low (at least until ARM fixed period expires in a few yrs).

So, I’m a perfect example of exactly the situation where taking on debt for the purpose of boosting invmt oppty makes sense. This is finance 101 – leverage boosts returns (though it also increases risks).

There is, of course, a level of debt that would create more risk that it’s worth – and we haven’t even begun to talk about that.

Lastly, despite being the right wayfor me, I don’t get how anyone can say there is one right way to address this strategy question. In my experience, people who are too dogmatic on these kinds of issues always represent a red flag.

26. FMF Says:
March 9th, 2007 at 3:12 pm

JLP –

Wow, what a discussion. Long list. Good. It’s nice to debate.

My point was that there is oftentimes a theoretical “best option” in personal finances that can be proven by the numbers but that, when it comes down to how people really act, doesn’t work practically (for most the vast majority of people.)

Based on my experience, this is one of those issues.

27. Lazy Man and Money Says:
March 9th, 2007 at 5:19 pm

I’m with JLP on this one. I see what FMF is saying, but there are two key points on why I wouldn’t suggest going with a 15-year mortgage.

1. As JLP mentioned, what if you run into a financial problem. You can basically change your 30-year into a 15-year by paying off more in advance, but you can’t change your 15-year into a 30-year and for a “break” on paying this month (even though you have been paying more on the previous months).

2. It’s very easy to set up automated payment for your mortgage. I did this in about 15 minutes one day. I haven’t had to do anything with it since. It’s also very easy to set up an automated payment to go to a mutual fund company each month. It takes about the same amount of set-up time and you only have to do it once.

There’s an argument to say that people don’t do the later (as FMF points out), but they also generally don’t put their money in 15-year mortgages. Either way there is a behavior change to be made and it’s basically the same amount of work. If the numbers are better investing elsewhere shouldn’t that be the behavior change that is encouraged?

28. Sam Says:
March 10th, 2007 at 1:53 pm

JLP,
Now you know how to generate a lot of comments – just blog on mortgages and/or Dave Ramsey. It has been a good discussion. Especially good to see how different folks look at the subject in different ways. Thanks.

29. The Sunday Review #11: The 2007 List Of Billionaires Edition Says:
March 11th, 2007 at 7:51 am

[...] A Follow-up to the Dave Ramsey Mortgage Post – This is Interesting! by JLP @ AllFinancialMatters.com: JLP runs some quick (and interesting) numbers to compare two situations: 1. Get rid of your mortgage very very early by making large payments, and 2. Instead of paying it off early, invest the additional amount over the span of the mortgage. Read the comments on this one ! [...]

30. WearyTraveler Says:
March 11th, 2007 at 7:49 pm

Very interesting topic and posts. I’m leaning more and more towards shifting a portion of my mortgage overpayment into my 401K and brokerage account. I’ve seen my investments beat the mortgage interest rates. I’ve still got a lot of thinking to do (to convince myself to take that leap), but I’m glad that it got me thinking. I just hope that I don’t invest in the next great loser in the market. All of the previous posts make sence AS LONG AS you pick the “right” investments to put your excess cash into. I was heavily invested in LU and MFN a few years back. Just think which creek I’d be in if I needed that money now.

31. » Weekend Linkfest on Blueprint for Financial Prosperity Says:
March 12th, 2007 at 9:04 am

[...] JLP has an interesting follow up to his Dave Ramsey mortgage post, a response from an employee of Dave Ramsey. [...]

32. fred Says:
March 14th, 2007 at 11:03 am

Most are people are not looking at the Risk by not paying off the house early and money that can be saved in interest. My wife and my self are 33 and 34 and we are debt free except the house and saving 15% (roths and 401k). We have an emergency fund already in place before we really started to attack the house. We have already paid down the mortgage by \$30k in one year and leaving us with a balance of 60K. We plan to have it paid off by December.

What I learned was if the house if paid off and you if take the money you were paying on the mortgage and invest it, you will come out ahead plus you will have reduced your risk. As far as losing the interest deduction, just make large donation to a church.

33. zen Says:
March 19th, 2007 at 6:44 am

I’d love to afford to pay off that much on a house payment – but it’s simply not realistic to us at this point. It’s a goal, no doubt, but definitely not feasible for everyone.

34. AllFinancialMatters » Blog Archive » Says:
May 8th, 2007 at 1:49 pm

[...] A Follow-up to the Dave Ramsey Post – This is Interesting [...]

35. db Says:
May 9th, 2007 at 3:31 am

I happen to watch the Suze Orman show, and last week she took a call on this very issue.

I don’t always agree with Suze, but in this case I think her advice was spot on:

1. If you are planning to be in the house short-term, don’t bother trying to pay it off any faster than the mortgage is set up for.

2. If you are planning to be in the house long-term, there is enough value in paying it off early that this is a good choice if it’s what you want to do. The reason: Even if you only make one extra payment a year and thus shorten the mortgage to 22 years, in the long run you’re freeing up some money that would go to interest as well as providing balance to the SECURITY vs FREEDOM question.

My take on it is that paying it off early doesn’t exclusively side with security, it also looks at freedom but in a different way. For example, I would feel a lot more free to pursue starting a business if I had a paid-for house than if I had a mortgage or a rent payment.

I don’t think putting money into savings/investing and paying down the mortgage needs to be mutually exclusive. Even if you can’t do a no-holds-barred-pay-off-the-mortgage-in-4-years siege — I’d think that many people could afford to budget in an extra payment to the mortgage a year without sacrificing your savings goals or causing extreme hardship.

Of course, if you’re really doing it Dave Ramsey’s way, you’ve got two incomes devoted to this mortgage repayment thing AND both of you have taken on an extra job to get some extra money. I think Dave’s 4-year concept has a lot of merit.

And I think that math doesn’t provide the full or adequate answer to anything. The truth is, we are emotional beings and we have to do what works both for our head and our gut. If you don’t mind the mortgage, keep it for 30 years. If it keeps you up at night, pay it off!

DB

P.S. — And not everybody has to be or think like a real estate “investor”. Personally I’d rather walk on hot coals barefoot than take on anything beyond a personal residence. It’s never worked out well in my family, and I’m stuck trying to finalize a messy property left to me by a relative that is a case study in how holding rental properties can be a losing proposition. Once this is done I’ll never engage in rental properties again.

36. Me Myself And I Says:
June 11th, 2007 at 12:48 pm

I agree with Miguel (in post #25), and anyone else who said it.
IT DEPENDS!

It depends upon one’s own circumstances. There is not a one-size fits all to this question. Each person has to assess their ability to control things (such as frivilous spending, as opposed to a sure method of keeping themselves on track).

We personally have a 15 year mortgage @ 5.5% (and only 13 years left). However, for my wife and I, we didn’t want to have a mortgage hanging over our heads when I near retirement (mortgage to be paid when I reach 56 years old). We don’t currently maximize our retirement contributions, by any means (after all, \$23,000/yr is quite a bit of money). But we are increasing the contributions every year. We are currently putting away 3%/yr, but are raising that every year by 1% or more.

37. Neith Says:
June 11th, 2007 at 4:38 pm

Truthfully, this discussion has made me think pretty hard about some things I took as given. For example, I make extra principal payments on my mortgage every month. After reading this discussion, I’m thinking maybe that isn’t the smartest thing to do with the money. We have a ton of equity in the house (major appreciation since we bought it), so I don’t think there is much risk in moving that money from making extra principal payments to other places.

Thank you for an interesting discussion.

38. brianl Says:
June 18th, 2007 at 2:43 pm

All this talk about security of having the mortgage paid off is BS.

If I have a mortgage of 200k, and I have 300k in the bank, the house is effectively paid off isn’t it? I can pay it off anytime by sending a check to the mortgage company.

The kicker is that a paid off mortgage means that you now have an investment equal to the value of the house. So now you are tied to the rate of return of your real estate in your market.

So 400k in a house at 5% is worse off long term than a mutual fund at 8%.

And here’s the real rub. To sell my house (to transfer my money to something else) is a 3-9 month process (plus a lot of sweat equity, packing things up, putting it on the market, etc). Plus I have to pay 3-6% in agency fees, closing costs, etc.

Versus a mutual fund where i get a certified check in 10 days. or a wire transfer in 72 hours.

While there’s an emotional value to having the house paid off, there is also an emotional and liquidity value to having easy to move money.

39. MS Says:
September 25th, 2007 at 11:10 am

Very healthy pros/cons…Basically it all comes down to how people end up managing needs Vs.wants and plan to retire healthy with very less burden & obligation. So, as DR(Dave Ramsey) says it is mostly behavioral changes than math. When I was a graduate student doing Phd, I lived within my stipend of \$850 a month (sharing apts., expenses, food, etc…) lived below my means. Now after over 13 years in workforce I wonder how I did that. Yes, income has changed since then but expenses too (home, kids, car, etc…).

But we never went into Plasma, no new car every 4yrs, no new appliances, etc…whats the point ! But we do have vacations paid for, & making a comfortable livng. So, if you see this life one lives it is the choices one makes on needs/wants and discipline & hard work to live well against so called status quo.

Pass on more wealth like these to kids than mere money (of course kids & their kids need more than us, factor in inflation, their inheritance-if any, running out of oil, etc…). So, financial freedom or security has to be a hollistic approach that includes prudent management of what one is worth (by their work), one can save, and one can pay in bare minimum in interest to bankers, creditors, fund expenses, etc…

Good Luck !

40. John Boujaoude Says:
October 9th, 2007 at 1:53 pm

The freedom of NOT having a mortgage, allows me to bum around for a couple of month each year….save on taxes that way!

Seriously, as a consulting engineer my income fluctuates widely from month to month (riches to rags), not having a mortgage allows living on the cheap.

The guy talking about having cash in the bank is not considering a serious illness that could wipe his 300k out.

In most states, houses are safe from bankrupcy.

41. Andrew Says:
October 29th, 2007 at 3:32 pm

What does not seemed to be considered in this conversation is that mortgages do not work like investments. The interest is ammortized or frontloaded in a mortgage. That is why the math seems so complicated. Over the life of the loan you are paying 6% interest, but the first year of a loan you are paying closer to 95% interest. If you look at the interest alone over the life of a 30 year loan it is often equivalent to the cost of the principle. But that is all paid up front. If you pay off your loan quicker you save all of that mortgage money which means in essence you are not getting the loan for 6% but for much less. then you can invest the monies at 8%. That is the real benefit of paying down a loan early. If you want to figure this run an ammortization table on a loan and look at a yearly breakdown. Then compare it to investing the money. The monies you save on the loan will convince you.

42. Michael Jankowski Says:
November 20th, 2007 at 4:50 pm

Re#41, yes, mortgages tend to me ammortized and have a fixed payment schedule with interest front-loaded and principle back-loaded. But that’s somewhat of a negative when it comes to paying them down early. If I have a 30-yr payment and decide I want to make an extra payment (including what I normally put into escrow and towards interest in a given month) in month 12, what I am doing is making the principle payment for the last month or two of the loan (payment #360 plus part of payment #359), saving the interest tied to those months (which will be close to nothing, since payments at the end of loans are almost all principle) and applying it to the principle, but doing so 348 months in advance of when the bill for that interest would be due. It doesn’t reduce my interest or payments anywhere else. It doesn’t eliminate the interest I’d be paying in month #13 and adjust the rest of my payments accordingly or anything like that. What is better for me – putting that money somewhere that generates interest/investment income for me for 29 yrs, or spending it now to avoid a small interest charge that isn’t due for 29 yrs? You make an extra payment in month 12 at \$1500 to save, say, \$150 of interest that would be due 29 yrs away…I would be much better-off taking that \$1500 and investing it. I should be able to easily average (10%)earning \$150 in interest EVERY YEAR for 29 yrs based on that \$1500 investment. You used \$1500 to save yourself \$150 of interest over 29 yrs, and I’ve used the same \$1500 to make \$4350 of interest over 29 yrs (ok, so taxes will take a little bit out of it, but I am also not compounding the interest, either). The more often you make \$1500, payments, the higher your interest savings will be eat time, and as the life of the loan gets closer to the end, the amount of interest I earn with those \$1500 investments will decrease since there will be less time to generate interest. So the final tally depends on how often these payments are made, what kind of rate of return I can get on my investments, etc.

If a typical mortgage worked in a manner like credit card debt, where the new balance due is re-calculated every month based on the outstanding balance, then you would really have a benefit to paying down a mortgage early, because extra payments would have a domino effect on all future payments. But since most mortgages are ammortized, extra payments eat away the debt that is at the back end – which is way into the future, and as you point out, very small.

One has to regularly and substantially pay-down an ammortized mortgage to see a free-and-clear benefit to doing so. And many people are simply better off putting that money towards investments. 6% is quite a cheap rate. If average people can’t invest and beat that annually averaged over 30 yrs, than we’re in big, big trouble!

43. T Says:
January 31st, 2008 at 1:25 pm

The second part of Dave’s pay-it-off-early plan is conspicuously absent; which is: after you’ve paid off your home, take what you used to put towards the mortgage and invest it. That aspect is missing from the OP as well as the discussion here – that changes the numbers significantly.

44. Steve Says:
February 7th, 2008 at 3:50 am

@43 – the OP did account for the money being put into investments afte the mortgage is paid. The problem is that the time value of money is lost when it is put into a home rather than an investment. When someone invests earlier, the time for compounding puts that money in the lead every time. And he did this for a 15 year being paid in 4 years, so you need to pay it off VERY quickly to come out ahead of the 30 year investor (It would be interesting to know what the break-even point would be.)

An earlier poster asked “would you borrow against a paid for home to invest?” Well, that depends. If I was 30 years old with a solid career and didn’t plan to move, then the answer is a resounding yes! I have time on my side, and I can afford to take the ups and downs of the market to make my overall return. If I were 60, then my time horizon is shortened and the proposition becomes much riskier.

When short time lines are considered, then the 15 year mortgage makes sense. For example, if you plan to leave your house in 2 or 3 years, then getting the 15 year makes sense for the short term. You pay down the principle faster and have a guaranteed rate, whereas the market could take a downturn for 3 years and result in a loss. Go past 10 or 15 years, and your risk in investing becomes mitigated. For any long term stay in a home (which only makes sense if you are going to pay it off), then going with a 30 year loan and investing the difference makes sense, especially if the difference falls within the range of contributing to an IRA, which also has a tax advantage on the investment returns.

45. ExamineEveryViewpoint Says:
March 20th, 2008 at 8:54 pm

@ post #8

Borrowing at 6% and earning 8%, you are making a 33.33% gross rate of return, not 2%. This is how banks make money. Man A deposits a dollar into his savings and the bank pays him 3%. Then the bank loans Man A’s dollar to Man B for a car at 6%. How much did the bank make? It’s not 3%, it’s 100%, think about it.

@ post 19

I like your thinking, but be careful not to think 401(k)’s grow tax free. They grow tax deferred. Any perceived tax savings today will be due later.

46. Rick Says:
August 31st, 2008 at 10:34 am

I’m going to stick with Dave for two reasons.

When my mortgage is paid off the house is mine and the bank can’t come take it. While several people have mentioned that the bank would rather invest in a 6% return guaranteed by your house instead of the 8% return used as the investment comparison, the risk of being on the other side of that 30 year mortgage is not even considered. Calculate for risk, and the equation is different.

Since everyone seems more into the numbers here, the second reason I’ll stick with Dave is because I haven’t seen too many investments making 8% right now. With retirement accounts that have had a -9% return over the past 2 years, I’d much rather invest any extra I have in owning my house sooner.

47. Comment on A Follow-up to the Dave Ramsey Mortgage Post - This is … Says:
August 31st, 2008 at 3:00 pm

[...] Read the rest of this great post here [...]

48. don Says:
November 2nd, 2008 at 4:14 am

Holy cow! this is the most cluless post i have ever seen, the author totally ignores the fact in his equation that if you paid off your house in 4 years you now have 26 more years to invest that payment into mutual funds and stocks, etc. YOU WILL HAVE ALOT MORE MONEY IN THE END…PAY OFF THE MORTGAGE….people who say not to just want your money..how disgusting

49. JLP Says:
November 2nd, 2008 at 9:05 am

Don,

Clueless?????

Did you READ the post before you left your comment? I do take that into consideration.

Maybe you should READ first BEFORE you comment.

50. Greg Says:
December 8th, 2008 at 2:33 pm

Very interesting read. I kind of wish now that I’d been hammering down my mortgage over the last 4 years instead of throwing money at the stock market. But now that the market has tanked so much, a part of me feels like now is not the time to go ultra conservative and throw everything at the mortgage note. Decisions, decisions.

51. john Says:
February 25th, 2009 at 10:17 am

Too many people here are doing exactly what the first person said not to do. Don’t take little chunks, but look at the whole thing. It is advocated by Dave that after you pay off your mortgage you continue to invest that money into the market. Once you have no debt and can invest all your income you will surpass the time that you wasted in those 3 years quickly. As for the guy that thinks that he is going to continue to get 33% – that is where the fantasy is.

52. Kirk Womack Says:
June 6th, 2009 at 2:09 am

Two years ago we stopped investing in our 401k and we began paying thousands against the principle on our home. We only have \$1,500.00 left to pay and the property is ours and we didn't lose our a\$\$et\$ to the stock market. We don't have to worry about losing our home to the bank. Our money isn't tied up in unstable companies that could fail in a second with no warning. We are debt free and will now be able to live comfortable lives without worry. There's something to be said about that don't you think? If all of your money is placed in the stock market, which most likely it is. You most likely are worried that you'll never get back what you just lost in the latest crisis. I don't have that worry and in 11 years, I will have saved approximately \$500,000.00 that I probably would have sank into the stock market and lost. Now that is a \$500,000.00 gain in 11 years. Can you beat that? I don't think so… Oh, and did I mention that God was in all of this? That is right! God. If we all would just obey the Lord and keep his word, "owe no man nothing" then we wouldn't be in the situation that were in today.

53. Deb Says:
September 13th, 2009 at 9:51 pm

This example proves that Dave Ramsey KNOWS what he’s talking about!

In this example the people who paid off mtg early apparently didn’t invest their extra cash and were almost even to the person who kept the 30 year mortgage.

If the payed off people truly didn’t invest the money that’s ok, look at all the years they lived in peace, debt free!!!

54. BeyondWeird Says:
January 25th, 2010 at 9:50 pm

Okay, So I’ve got a 15yr mortgage interest rate of 4.375% fixed, & no other debt. I’ve maxed out my 401k contributions each year, & can’t do a Roth due to income level. One “child” is now 25, the other is 18 & 529 College money is set aside. Not bad, so far.

I’ve got about a year or two of emergency fund set aside, and I STILL believe one of the RISKIEST choices I could make is paying off my mortgage early!

As has been said earlier, you get no good behavior credits for paying early – in other words if you’ve paid \$1000 per month additional for years, and you’re late on your payment next month, or you start missing payments, that extra money you’ve been paying won’t do you a bit of good…. you’re still late, you will still eventually be forclosed on, and it won’t matter if the mortgage balance is \$150,000 or \$50,000! Now if you had INVESTED that \$1,000 per month in a liquid asset, you could use it to pay the mortgage if you fell on hard times. That extra \$1,000 per month would have possibly paid the mortgage payment for YEARS, during which time you would have been able to “float your boat” and move (takes money), or find a new job (takes money). So having LIQUIDITY could mean the difference between being stuck in a depressed market with no money at hand.

I work in a volatile industry, and I think I’ll stick with my CASH, and my net cost of funds 3% mortgage, after I take my mortgage interest tax deduction… and INVEST wisely instead…
IMHO

55. FinancialDave Says:
May 12th, 2010 at 5:39 pm

Now “BeyondWeird” has hit the nail on the head – CASH is king, as long as you don’t “plop” it down on your home mortgage. It’s amazing how much a \$29 financial calculator can keep you from making a 1.5 million dollar mistake. Say you have a windfall of \$200,000 and you want to pay off that home mortgage, just so you are free of that \$1104 mortgage payment (5.25%.) Ok, let’s look at what you just lost in income over 30 years — that \$200K would be \$3,967,000 @ 10% rate of return. Now what did you gain – \$1104 @ 10% for 30 yr. is \$2,495,000 — basically a \$1.5 million dollar mistake.

56. Beentheredonethat Says:
July 2nd, 2010 at 9:08 am

Interesting read. I paid off my 30 year in 3 years in 08 just before the market tanked and have invested the payment for the past two years. Alot more money in a cheap market. What also is not stated in these calculations are other freedoms. Yes we all want to expand our wealth but we also want to live an enjoyable life. I am comfortable spending money on vacations or whatever I desire, in cash, knowing that if a financial issue arrises I can stop my investing and have the previous mortgage money for use. Mathmatically you might make more money but, for me, I want to have a life while doing it. Having no debt reduces ones stress level, affords you new freedoms and also allows you to “play” the market at the same time. Had I kept my 30 year mortgage I would still be paying it off, reducing the amount invested each month by my mortgage payment, been unable to move when I wanted where I wanted. I rent that house now and pocket the rent, while living overseas and having my rent paid for by my employer.

57. Mike Says:
May 11th, 2011 at 10:11 am

Forget the math! Use common sense.
I am on Step 6, trying to pay off my \$86,000 mortgage before age 30.
It’s putting money I already make toward the debt.
If I weren’t applying it to the mortgage, I might be spending it.
Certainly not saving it with the terrible rates.
You can check my progress on my blog, if you are interested.
I’ve got about four years to go!