In this month’s edition of “Money Matters,” Scott talks about key factors to consider when deciding whether you should pay off your mortgage debt or invest money in the market.

Factors to Consider Regarding Paying Off Your Mortgage

The chart below includes additional factors to consider when deciding to pay off your mortgage or invest that money in a different opportunity (click the image to enlarge). If you have questions about paying off your mortgage or other investment options, please contact me anytime to discuss—I’m happy to help navigate you through your unique situation.

Money Matters: Should I Pay Off My Mortgage or Invest in the Market? Transcript

0:00:00.1 CJ: WTIP is pleased to bring you another edition of Money Matters, a monthly feature intended to help us understand more about managing our finances. Scott Oeth is a certified financial planner, an adjunct professor. He's taught retirement planning and wealth management strategies to hundreds of financial professionals, and he's joining us now by phone. Welcome, Scott.

0:00:21.2 Scott Oeth: Good morning, CJ.

0:00:23.7 CJ: Good morning. So you wanna talk to us about debt today?

0:00:29.1 SO: Yeah. This is a really common question now, and I'd say over the last 20, 25 years of being in this field and working with clients, it has always been a common question. But in particular, I want to look at something... A lot of folks are at refinancing their mortgages, the housing market's very hot, so one particular area of the debt market, home debt, I thought would be worthwhile for us to talk about, because it's a very common question to wanna know, should I accelerate payments against my home mortgage? Should I paid down that debt quickly? Or if I'm in that fortunate position where I have a bit of excess cash flow or I come into a lump sum of money, should I put that into investment portfolio? What's gonna be better for me over the long run?

0:01:12.3 CJ: And what do you think?

0:01:14.1 SO: Well, there's no one-size-fits-all, so people really need to carefully analyze their own situation. I know I often say that as sort of a caveat, but in this case, I think it really is true. Both situations can be a win. Putting money towards the investment portfolio can work very well for you, over the long run, paying down debt can be a good thing as well, but there are different pros and cons I wanted to talk through a little bit. One of the things I'm seeing is interest rates are at all-time lows, so there's not a whole lot of incentive to pay down that debt, and that's a very different situation than to the late 70s, very early 1980s, when we had double-digit interest rates, at higher rates.

0:01:49.8 CJ: Right.

0:01:51.1 SO: But stock markets are also hitting all-time highs, and a lot of folks are nervous about investing, with stocks sort of at a high point as well. And so some people, I'm hearing questions, "Well, what do I do? It doesn't seem like there's a clear answer." And there are certain personal finance gurus out there with big audiences, who I think help a lot of people but giving really strict, strong advice, but often the message there is pay down debt quickly, no debt, not even your home mortgage. And I'm not necessarily in that camp. I think paying off debt can be a great thing but it may... Also might not be the optimal thing, in many cases.

0:02:28.5 SO: And mortgage debt is very different than, say, credit cards or consumer debt. Mortgage debt typically has lower rates, typically fixed, and you're using it to purchase an asset, something that lives on the asset side of your personal balance sheet, something that typically has grown over time. Residental real estate over, say, 10, 20, 30 years has gone up with... At least with the rate of inflation, unless you have a real problem property, and usually a bit more. So you'll hear conversations saying, "Well, gee, look at a 15-year mortgage versus a 30. Look at how much you save in total interest payments [0:03:01.3] ____ that long." That's true, and those are real dollars that are being spent, but it ignores the asset side and what's happening on the asset side of your balance sheet, and how that might be growing. So you can't ignore the positive benefit that can come from having good debt like this on a property as well.

0:03:19.3 SO: And also this gets a little bit deeper and tricker to think about, but when you borrow money to buy an asset, say, a house, and you're only putting down a portion of the purchase price, and you're borrowing the rest, it's possible to have positive financial leverage. You're able to borrow money at a very low rate from the bank, maybe you put down 20% on the value of that property, and over time, that property is growing in value. You're capturing the return on the full market value, but you only have 20% of equity in the property. The closer you get to having that property paid off, you're diminishing that leverage, and your effective return is getting closer to just the market return on that property, which is probably... Historically, it's been something like 1.5% over the rate of inflation. So there are a few things... Say, paying off debt can be a good move, but it might not be the optimal. There's some other factors you really need to take a look at.

0:04:19.3 CJ: So I was listening to the radio this morning and hearing that the top 1% of people in the United States, in terms of financial health, control more than... More in the stock market than the rest of us, by far. It seems like the little guy who tries to buy a home doesn't have a lot of money left over at the end of the month to invest in the stock market. And savings, you're getting nothing if you try to put it into a savings account. Kind of in a bind.

0:04:56.2 SO: Yeah, you're right. Bank savings, they're safe, they're guaranteed. Those are the good things. I think it is a very important thing to have some emergency cash, the rainy day fund, so to speak, in the bank. And you're not gonna earn much money. In fact, you'll be paying taxes on that measly amount of interest you get, and your purchasing power is probably actually decreasing if you have a lot of money sitting in the bank, because inflation is likely to be running higher than the interest rate you're earning on that... Those dollars left in the bank. But it is important. You need some type of backstop for a tough situation, the car breaking down, or an unforeseen medical expense, or a home repair even. So, you do need that. I think if you can get yourself in a position where you're buying a home, and if that's the right thing to do for you, that's day one. And hopefully, your situation, you work to improve it over time. Your earnings will probably go up also with inflation over a period of, say, 10, 20 years. And as you accrue extra dollars, there still can be that point of what do we do? Do we put a little bit extra towards the mortgage, which could be a good thing? It's essentially giving you a guaranteed return by reducing the mortgage by the rate of that interest.

0:06:10.6 SO: So that's a good thing. There is a trap that I wanted to highlight. I think this is a tricky situation. For a lot of folks in the situation you're describing, they might be scraping and putting an extra 25 bucks a month towards that mortgage, or maybe they're even doing better, they're making an extra mortgage payment every six months or every month. That is a win and that's a solid step, financially, but the problem is if you lose that job, guess what? Next month, the mortgage payment is still due, and the month after, and the month after. And so, even though you've been improving your situation, you've been diligent and you've been making extra payments towards that big mortgage, that's a big liability on your balance sheet, you have to think about that. Having a paid off mortgage can be a good thing but, hey, guess what? Having cash in the bank or maybe that next step, investing in your retirement plan at work or investing in an IRA or even just a broker... That can be a very good thing too, and those are more liquid dollars that you could use to make those extra mortgage payments if you lose the job. So there is a balance. As I say, I really think it works for folks. They need to carefully think through their situation, seek expert advice for their own situation, and there's a big part of it too, of knowing yourself, I think is very important.

0:07:26.6 CJ: Right.

0:07:27.4 SO: What's the right answer for one person might not be the right one for the other, and sometimes it comes down to the psychological, the behavior issues, because, well, I like having flexibility, that I described, the ability to go get assets that are in a retirement savings account. The trap there is you have to be disciplined because, boy, all of a sudden, those dollars might look like they're available to splurge on a fun trip or buy a boat, or something that might be a lot of fun but isn't necessarily improving your financial situation. So the investing the extra dollars, it really only works if you have some discipline there to keep that money in play for you over the long haul.

0:08:06.8 CJ: And if you...

0:08:10.2 SO: Same thing could be said about the... Sorry, the same thing could be said about the home equity because, as we saw in the mid-2000s, people were just continuing refinancing, and taking home equity loans, and then spending that money as well. So, either way, it really requires discipline over the long run.

0:08:21.2 CJ: Indeed, you have to know yourself, how risk-averse you are, and what your comfort level is.

0:08:27.0 SO: That's right. Yup. Yup. Comfort level, what's gonna feel better, sometimes just having that debt paid off. I've had many clients over the years tell me they just wanna have the debt paid off, and that's not wrong. That's not a bad thing. That's a very good thing. Being more comfortable with your financial situation, it can give you freedom to make better financial decisions in other areas, or maybe having that mortgage paid off gives you a little bit of freedom to feel like, you know what? I am gonna take this other job that I really want to do, but maybe it pays less, or maybe it's commission-based, or maybe it's starting my own business, where there's some uncertainty there that you normally wouldn't feel comfortable taking without that mortgage being paid off.

0:09:05.5 CJ: Indeed. Well, very good advice, as usual, Scott. We're talking with Scott Oeth, and we're talking finances on the first Wednesday of the month, on North Shore morning. Anything you'd like to add, Scott?

0:09:19.1 SO: I've really enjoyed the conversation, and I just point out, someone's listening in the car, or while they're at the gym, or whatever, we've been archiving these episodes, they're on WTIP's site, and I've also been putting one in my own blog, scottoeth.com, in case someone wants to go back and listen more. But I've really enjoyed it, CJ.

0:09:38.3 CJ: Thanks, Scott. We'll check in with you again next month.