By Dr. Jim Dahle, WCI FounderI've noticed an interesting phenomenon. People who would like to pay off their debt are a little bit embarrassed about it. They might even feel stupid to do so. Other people are actively belittling them for being so unsophisticated as to not use “the tool” of debt to acquire more wealth. The lower the interest rate, the more people feel and are made to feel dumb about paying it off.
That needs to stop. We paid off our 2.75% mortgage way back in 2017, and we haven't had any debt since. Sometimes people try to make me feel dumb about it. You know what I ask them? I ask them if their net worth is higher than mine or whether they've already reached all of their financial goals like I have. If it isn't or they haven't (and that is usually the case), I then ask why in the world I would take financial advice from them if I'm ahead of them in this (admittedly single-player) game? Forty percent of homes are paid off these days. Almost none of those homeowners seem to regret it. Are they all idiots? It seems less likely than the alternative, i.e. that they know something the “always-in-debters” don't know.
No, You're Not Stupid for Paying Off Your Debt (Even Low-Interest Rate Debt)
Like me, you'll probably have to use some debt for part of your life. You may or may not choose to use leverage beyond the point of necessity to reach your financial goals. But there are a few reasons why it's not stupid to pay off your debts, and even those who think “other people's money” is the best pathway to wealth should be aware of them.
#1 It Doesn't Move the Needle
The first is that, in many cases, it just doesn't move the needle. Here's a classic example. Someone goes in to buy a car and discovers that the financing office will loan them the money for the $15,000 car at 3% over the next three years. They also know they are currently making 5% in their money market fund. Instead of using their own $15,000, they use the dealership's $15,000. They feel so smart. They feel so sophisticated.
But what is their move actually netting them in exchange for the hassle of making payments? Let's say they have a finance charge of $150. They have to earn that back before they get anywhere. Then they have to adjust that money market yield for taxes. Let's say they have a 25% marginal tax rate, so they're actually only earning 3.75% on that money market investment. Over the course of three years, they pay $704 in interest, plus the $150 interest charge, for a total of $854. Meanwhile, they earn $883 in their money market fund. The net result is $29. Yeah, you're pretty sophisticated. You could have just skipped one stop at Chick-fil-A for the family during that three-year period and come out ahead, and that doesn't even count the value of your time in the finance office or checking your accounts to make sure each payment went through.
The larger the difference in interest rates and the higher the total of debt and the less wealth you already have, the higher the chance of this moving the needle for you. But I encourage you to actually run the numbers and calculate it before you feel any shame for not doing it. A $200,000 mortgage doesn't move the needle for pentamillionaires, and a $15,000 car loan probably doesn't move the needle for anyone.
More information here:
The Wrong Way to Think About Debt
#2 Better to Earn Interest Than Pay Interest
The second reason is a mindset issue. I started teaching my kids when they were very young that it is better to earn interest than to pay it. Seems a worthwhile lesson, right? Especially when there is more than $1 trillion in credit card debt in this country, and reports say that 56% of accounts carry a balance at an average rate of 21%. Sixty-one percent of Americans have credit card debt. More than 100 million Americans have a car loan. Now, you want to start muddying the waters.
- “Sometimes it's OK to have debt.”
- “Debt can make you richer.”
- “Paying off debt is dumb.”
I'm not sure your messaging is doing as much good as it is bad.
#3 We Spend More When We Use Debt
One of the greatest arguments against using debt and having debt is that the studies are pretty darn clear that, on average, you spend more when you borrow the money. Eighty percent of new cars are financed, but only 38% of used cars are financed. Coincidence? I don't think so. Pretty rigorous studies show that we spend 12%-18% more when using a credit card than we would have if we were spending cash. Those struggling to spend can take advantage of this, but that's not most people. It's not that big of a jump to go from there to saying that those who carry debt probably spend more than those who don't.
#4 We Don't Really Invest the Difference
Nobody is arguing with the math. If you borrow at 2% and then invest the same amount of money at 5%, you'll come out ahead. The problem is the unspoken assumption. The assumption is that you will actually invest every dollar that would have gone toward paying off that debt. Give me a break. This was actually a big reason why we paid off our mortgage. We weren't investing those dollars. We were spending them. And if you're honest with yourself, you probably are, too. People like to say that paying off debt is an emotional decision, that it just makes you feel warm and fuzzy. No, those who pay it off just recognize their own humanity.
More information here:
Should You Pay Off Debt or Invest?
#5 We Don't Adjust for Risk
Here's another problem. Some people say, “I'll keep my 4% debt because I expect to earn 8% in the market.” Well, paying off that debt is a guaranteed return. Stocks, real estate, and many other investments don't provide guaranteed returns. The only proper comparison for debt is to a risk-free investment, like a Treasury bond. So what's the Treasury bond yield as I write this? It's about 4%. Weird.
#6 We Don't Adjust for Taxes
While you're making adjustments, make sure you adjust for taxes. For example, somebody might think that they're getting a great tax break for their mortgage or that their after-tax mortgage rate is only 4%. Then, when they really dive into the details, they discover they're taking the standard deduction and that mortgage interest isn't even deductible. Oops. Adjust both your investment returns and the debt itself for taxes to make a proper comparison. If you don't know how to do that, you have no business carrying debt unnecessarily to invest.
#7 Improved Cash Flow
Maybe it wasn't the best mathematical move to pay off our mortgage seven years ago. But I can tell you this. For the last 84 months or so, I've had an extra $2,500 a month with which I can do whatever I want. I can invest it. I can spend it. I can give it. Whatever. I have more cash flow than I did before. This is particularly noteworthy in the retirement years. Someone might have a $200,000 mortgage that still has a $3,000 a month payment. That's $3,000/month * 12 months/4% = $900,000 of their portfolio that is “tied up” paying for this mortgage. Better to just pay it off with $200,000, leaving you to spend 4% * $700,000 = $28,000 extra per year.
The counterargument is that you're less liquid. The thing about liquidity is that you only need enough. Once you have enough, more is not beneficial. Most retirees and most successful investors have plenty of liquidity. But obviously, you don't want to pay off your mortgage using your emergency fund when every other dollar you own is sitting in a 401(k) invested in stocks.
More information here:
The Nuts and Bolts of Investing
How Fast Can You Get Out of Debt?
#8 Remove Leverage Risk from the List of Risks in Your Life
When you've won the game, stop playing. When you no longer need to run a risk to reach your financial goals, stop running it. Leverage risk is needed by most of us at some point, but that doesn't mean it should always be taken. If you decide to continue to take leverage risk, be intentional about how much you take. There are very good reasons to limit your total debt to only 15%-35% of your total assets.
#9 Being Debt-Free Is a Status Symbol
- “Oh, you have a mortgage? How quaint.”
- “I'm sorry you have to take leverage risk to reach your financial goals.”
- “I had a mortgage once. How do you like yours?”
- “Wow! You have an 820 credit score. I don't really know what mine is. Haven't checked in years. Haven't needed to.”
See what I mean? Bragging about your debt is like bragging about your individual stocks. It just kind of makes you look like you can't manage money. Somehow we've turned the shame-gun around and are pointing it at those who don't have debt instead of those who do. How'd that happen? (Not that I really think it should be pointed at anyone; shame usually isn't all that helpful.)
#10 The Warm and Fuzzies
Maybe the emotional effect of paying off debt actually does have some value. If you can't use your money to make you feel warm and fuzzy, what good is it? It's supposed to make you happier, so why not let it make you happier? If paying off your debt will make you happier (like it does for most people), then pay it off. Many people express a feeling akin to the lifting of a burden from their shoulders when they pay off their car, credit cards, student loans, or home. They should be happier; they've accomplished a goal, an important milestone in their life. Even if their net worth didn't change, net worth isn't everything. And very few of them go out and take another student loan or another mortgage because they miss it.
If you don't want to pay off your debt, I don't really care. Have fun with it. If it's a $20,000 0.9% student loan or a $150,000 3% mortgage, it's probably not going to hurt you much to do that even if you don't invest the difference in a Spock-like manner. But quit shaming those who are almost surely doing the right thing for them by paying off their debts.
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What do you think? Why do people feel stupid paying off debt? Why do others shame them for doing so?
My brother encouraged us to keep our 4.2% mortgage and invest in stocks. He had no mortgage and has been living off his stock portfolio for decades (as husband told the kids when one asked why he had to work, unlike Uncle visiting us in England then for 3 months, “because Uncle D didn’t get married and have two kids”).
After seeing stock options we had been doing at brother’s advice was a great deal of tax time paperwork for minimal gain I questioned his advice re the mortgage. Yep, I decided even back when we actually got a deduction for the mortgage interest, a guaranteed 3.1% post tax return and no mortgage payment in retirement we were about to start was more attractive than possible 6% post tax return but also potential risk of 1-2% return for a few years with bad ol’ SORR.
We moved recently and after getting a 3% mortgage for that annoying interval of owning two houses we paid it off ASAP*. As our (new) local housing market seems to be booming I occasionally regret not buying a fixer up rental or flipping** but as spouse reminds me “that’s a young man’s game, we don’t need to work that hard”.
*It was also much easier I am certain to get a mortgage, not a SECOND mortgage, when we hadn’t yet sold the old house.
** And paying cash for the investment house but paying 3% for that cash via our mortgage vs much more for any non owners occupied house loan.
Another great reason is that the bank holding the mortgage no longer has any say over what you do with your property! We had massive damage due to hail and the bank wouldn’t give us our insurance check. We had to deposit it into their account, and show progress checks in order to draw the money to have the repairs done. I hate knowing I don’t have full control over my own property! I can’t wait until I can fully pay off my mortgage!
Excellent point.
I’ve never heard of anyone shaming anyone for paying off a low interest mortgage, but I suppose the assertion keeps the playfully divisive “Suzie Orman listen up people!” spirit of this newsletter firing on all cylinders.
That said, we have a 2.75% mortgage that we took out as a cash out refi on our home and used proceeds to pay off a 4.25% 3 year adjustable investment property mortgage, so our accountant “signed off” on deducting the interest. But…given that I lean toward just amortizing it, the decision has more than one moving part. One thing is, as you alluded to, it increases your cash flow much more than the interest rate would suggest, though only for the remaining term. We owe 80K, with 5 more years to go, total annual payments about 18K. That’s a 22% return for 5 years. Sort of like a “reverse annuity” in a twisted kind of way. So if cash flow were really important for the next five years vs. the next few years, I’d lean toward paying it off. Another thought is that it would be a good way to insulate a little money from an overvalued stock market. (Perhaps I’d liquidate VTSAX to pay it off, reducing that asset class just a few percentage points for a guaranteed 2.75% return). Some might call that market timing, but just about every move we make has some sort of timing element to it.
Great article outside the snarky undertone. You are a thorough thinker and have really gained perspective reading your step by step dissection of ideas.
Keep listening, I bet you will, at least on an online forum.
Hope it’s not too snarky. My hope is that makes reading about a relatively dry subject a little more interesting, but sometimes I just totally miss and it turns someone off.
For people with a 3% mortgage vs a new one at 7%, each $100k borrowed would cost another $4k / year (approximately). Even if someone is borrowing $500k that’s an extra $20k / year.
On a typical physician income that won’t make the difference between financial success or not. It’s more how much you spend of the rest of the income.
I agree being debt free is good, but I’d personally recommend maxing out a 401k, mega backdoor Roth 401k, backdoor Roth, and 529 (if living in a state with an income tax) and having an adequate emergency fund before paying down low interest debt. I would pay down debt in place of taxable investing and have a lower bond percentage than I would otherwise with a paid off mortgage.
That was kind of what we did. We didn’t ever miss out on a retirement account contribution to pay down the mortgage. When we had more to invest than fit in the accounts we started considering it.
Thank you for writing this. I am a long-time reader of the bogleheads forum and the topic of paying off mortgages often comes up. There is frequently an undercurrent that people who pay off mortgages early (especially those with relatively low interest rates) are making an unoptimized emotional decision. Sometimes this feedback comes across as snide condescension. Nice to have well thought out counterpoints to refer to!
These arguments all make sense, but what about mortgage debt for a rental property? Without the debt we’d have a taxable profit on the rental income, and we’re in the highest tax bracket in a high-tax state.
Great point, I’m in the same boat.
So let me see if I follow your reasoning. Because you’re in a high tax bracket and a high tax state you were hoping not to make more money? That doesn’t make any sense.
But yes, do apply taxes to everything before making any decisions. You may have a better use for your money than paying down the mortgage on your rental properties or you may not. For example, it wouldn’t make sense to be buying bonds paying 2% instead of paying off a 5% mortgage.
I don’t plan on paying back my 30 year, 400k mortgage at 3.25% a day early. With mortgage interest deduction and my top tax bracket of 35%, it’s basically a 2.1% loan. Unless I’m missing something?
Not many people deduct mortgage interest these days after the tax code changes that were made a few years ago, but it makes sense if you are one of those that still do
And the high earners that are our target audience, especially generous ones who live in HCOLAs, are going to be a big chunk of those people.
“Someone goes in to buy a car and discovers that the financing office will loan them the money for the $15,000 car at 3% over the next three years.”
“A $200,000 mortgage doesn’t move the needle for pentamillionaires, and a $15,000 car loan probably doesn’t move the needle for anyone.”
How many of your high earners in high cost of living areas are buying $15,000 cars or $200,000 houses?
Seems like you set up your example to support your argument rather than to reflect reality—or at least inconsistent with the audience you purport to be addressing.
On the cars, not as many as should be! I really don’t think anyone ought to ever have a car loan larger than $10K.
As far as the house, hard to find a $200K house anywhere right now, but as mortgages are paid off, at some point they pass the $200,000 mark.
As far as the argument, if you’ve got a $100K car loan or a $2 million mortgage, that’s a much bigger piece of your financial life. The argument in that section was that the little stuff doesn’t move the needle.
If you’ve read this article and still want to keep it, then no, I don’t think you’re missing anything. Be sure to look at your Schedule A before deciding you really have a 2.1% after-tax mortgage rate, but even 3.25% is pretty darn low.
If you are getting health insurance via the ACA exchanges, not having to pay a mortgage reduces your annual income needs and thereby increases your Premium Tax Credit by 6-8%.
Re #6: The ‘tax benefit’ of having a mortgage and itemizing is only the extra amount you can deduct above the standard deduction – since you always get the standard deduction.
An excellent point.
As far as deductions, depends on what else you have. If you always give more to charity than the standard deduction, mortgage interest is definitely deductible.
Via email:
I have always respected you modeling good choices. I was surprised to see you so boastful in criticizing those of us who are not so well off to pay off our mortgages which apparently means we are unintelligent and not worthy of being able to hold a financial conversation while we provide for our families. I hope whatever got you to that place gets better in your life—especially where those of us who need mortgages have subsidized your wealth and the growth of your business.
and the response:
Sorry if the tone on that piece didn’t come across right. It is directed at those who CAN pay off their mortgages and choose not to and then like to belittle those who do.
It is not directed AT ALL at those for whom that isn’t an option. While paying off a mortgage was always a priority for us, we had one for 4 years on one property, 9 years on another, and 7 years on another for 20 total. Paying it off wasn’t an option for all but the last 1-2 of those years.
Someone can probably figure out some interesting math equation for this, but I always thought that this simple rubric gave a good time to pay off a mortgage.
Years of living = Total Investment Assets/Total spending in years. When years of living (minus the mortgage balance) was higher without the mortgage spending, I paid it off. Never regretted it.
Interesting. Never heard that before. I guess the point is that when you’re that rich, investing on leverage is no longer particularly important. Seems reasonable for sure.
I always thought I would pay off my mortgage when I had a lot of money.
Now that I have reached Critical Mass/Financial Independence (for me it was better to be lucky than smart), the question is, would that be wise in my case.
It would mean dipping into my 401K/IRA, and paying 50% of the amount I took out in taxes.
If it was paid off, that would feel really nice, and as the saying goes, money not going out (for the mortgage) is like money coming in.
And I would still have: 8 figures in my retirement account, defined benefit pension, SS, W2 (still working 1 day a week at 71), small 1099 gig, and fully paid medical for life (former employer reimburses all of our Medicare premiums).
I know what a Financial Advisor has told me it the past – “no, you would get killed in taxes”).
But my wife feels the opposite, and would feel better if it was not hanging over out heads.
I can see it both ways.
I did sign up for a free 15 consult with Rick Ferri, but haven’t yet been successful in winning one of those rare spots on his schedule.
I probably wouldn’t raid my retirement accounts, especially before age 59 1/2, to pay off a mortgage early. But you’ve got 8 figures in there and you’re 71. Very different from a 40 year old. So yea, if you want to be debt free, you could do it over the next year or two or three to spread out the tax bill. Does it matter with $10 million plus? Probably not. Either is fine.
Congrats on your success.
Loved this article. Completely agree. Debt is like a chainsaw, it can be a powerful tool that can accomplish a lot when needed. It is also very dangerous. Why continue to use a dangerous tool any longer than necessary? Your perspective is so much more realistic than Dave Ramsey’s even though his very black-and-white rants are more entertaining. Thankfully, I come to WCI for knowledge and save fulfilling my entertainment needs for YouTube shorts. Happy New Year Jim!
It’s a lot easier to ignore nuance, but as Einstein said, make things as simple as possible but not simpler.
Paying off debt is one of the smartest financial moves you can make, even if it might feel difficult or daunting at times. Here are 10 reasons you’re not stupid for focusing on debt repayment:
1. You’re Building Financial Security
Paying off debt, especially high-interest debt like credit cards, puts you in a better position to save and invest for the future. The sooner you pay it off, the more financial freedom you’ll have down the line.
2. It Saves You Money in the Long Run
High-interest debt can cost you significantly over time. By paying off your debt, you’re eliminating the need to pay interest, which can often double the cost of your purchases. For example, credit card debt can have interest rates upwards of 20%, so paying it off quickly saves you money in the long term.
3. You’re Reducing Stress and Anxiety
Financial stress is real, and carrying debt can be a heavy mental burden. Paying off your debt leads to a sense of relief and control, reducing stress and giving you peace of mind about your finances.
4. Improving Your Credit Score
Paying down debt, particularly credit card balances, can help improve your credit score. A higher score means lower interest rates on future loans (like mortgages or car loans), which can save you even more money.
I count 4. Where are the other 6?
5. Personal interest expense (credit cards) is nondeductible on your tax return.
6. Little or no benefit from mortgage interest due to high standard deduction.
7. Mortgage interest on indebtedness in excess of $750,000 or $1,000,000 (half for married filing separately), depending on mortgage origination date, is nondedeuctible.
8. Home equity loan interest is not deductible if loan is used for personal expenses.
9. Interest expense on loans used to buy tax exempt securities is nondeductible.
10. Interest expense on loans used to buy investment property (other than royalty property which is reported on Schedule E) is deducible only to extent of investment income (interest, dividends, gains) treated as ordinary income, and only if itemizing deductions on Schedule A.
You seriously carry balances on credit cards. Really? Seems an odd argument to make here. I don’t think I know any particularly financially successful people who do that, much less advocate it.
This whole list seems like it comes from a blog post or something that neither of you is linking to. What am I missing?
I ignore everyone who judges my decision to pay off my 2.75% mortgage early. My plan was always to be mortgage free by the time my oldest started college. If our 529s were not going to cover the full four years, I wanted to have extra cash. I am now paying out of state tuition for one, and in state tuition for the other. Bring free from the mortgage payment means we don’t skip a beat. And I never miss maxing out my 401(k), contributing to 529s, maintaining an emergency fund, or investing in an S&P index fund. I feel great about the decisions I’ve made. If someone else feels great about making different decisions, good for them.
The truth is that most people who pay off debt also invest. And most people who don’t pay off debt don’t invest. It’s not either/or.
I’ve had lots of people tell me I was dumb for paying off a 2.75% mortgage. I don’t recall anyone wealthier than me ever telling me that though.
Not to mention when you are leveraged less, there is a psychological ability to take risks more easily that may have more than just a monetary gain. The risk of entrepreneurship or being able to pivot to a job with better work life balance. That freedom is worth at least a few percentage points to me!
Agreed. The biggest financial risk in my life isn’t leverage related. Market risk and leverage risk pale in comparison to entrepreneurial risk, but it is easier to take those sorts of business and career risks when you’ve got the other financial risks in your life controlled.