Does paying off a mortgage early buy security?

If you look back through my articles, you’ll notice a frequent topic is paying off a mortgage early. I talk to people everyday that are at various stages of their life. Some are young and fairly new homeowners. Others are in or nearing retirement. Whether young or old, everyone seems to take some measure of pride in paying off their mortgage.

The side I see all too often is the client who is nearing retirement and who doesn’t have nearly enough savings to retire. A little fact finding reveals…

• Their mortgage is satisfied and they own their home free and clear.
• Their home is worth more than they have in savings.
• They’re having a hard time remaining where they live.

Every dollar of principal that you pay down on your mortgage is a dollar that is now trapped in the house earning a zero percent rate of return and contributing nothing toward your retirement.

You will not see that dollar again until you sell your house. Would you be happy with your 401(k) if it didn’t increase every year? Are you upset when the value drops?

“Yeah, but Tom, I have the peace of mind that the bank cannot ever take my house”

Is this what you are thinking? This is the number one thing I hear from people. But do you know what else I hear from these very same people?

“We’re thinking of moving because we can’t afford to live here any more. The taxes are killing us.”

Can you lose your house if you don’t pay your taxes? Damn right. So why is there so much irrational concern over losing a house because of the mortgage?

Your mortgage payment is constant for the term of the mortgage. It will never change and it will go away completely at the end of the term. Your gets cheaper every year in real terms because it is not subject to inflation.

Property taxes, insurance, utilities, and homeowners association dues all increase every year. Property taxes and insurance are both tied to the value of the house so their cost probably rises faster than the overall rate of inflation.

Your house may be paid off in less than 30 years, but these other expenses keep increasing and will become a burden in retirement.

This chart shows a projection of annual homeowner expenses over 45 years. This assumes a level 30-year, fixed rate mortgage followed by 15 years of retirement. There is no early payoff of the mortgage in this example.

One thing that is immediately apparent is that if property taxes and insurance are both increasing at the rate of home appreciation, they will be roughly equal to what the mortgage payment had been by the end of the 30 year mortgage. These expenses will be there whether there is a mortgage or not.

Another observation is that the mortgage is only a small part of the total cost of homeownership by the end of the 30 year term.

Conclusion:

This chart explains exactly why so few people are ready for retirement by the time they reach retirement age.

1. 1. They likely make extra payments on their mortgage as their incomes rise instead of saving that money for retirement. You can’t pull income out of the walls of a house.
2. 2. The taxes and insurance may become a significant component of your retirement budget. You can still lose your house if you don’t pay your taxes. Take it from someone who invests in tax lien certificates!
3. 3. Taking the payments that would be applied to principal on the mortgage and investing them early in the mortgage adds far more value than an investment in equity at a zero percent rate of return.

Here's a video that explains this concept graphically:

https://www.youtube.com/watch?v=KZPyY9k0L5M&t=16s

Paying off a mortgage may buy peace of mind, but it doesn’t buy security.