**By Dr. Zachary Zemore, Guest Writer**

Being only a few years out of residency, I am deeply immersed in the accumulation phase of my financial journey. Like many readers, I have read all the old White Coat Investor blog posts and have a firm grasp on the financial essentials, such as establishing a proper budget, minimizing expenses, and paying off student debt in a timely fashion. At the same time, I am also maxing out my 401(k) and executing a Backdoor Roth IRA, and I have opened a brokerage account. Thanks to my low cost of living, even with these financial sinks, I still find myself with surplus funds which can be mobilized for actionable financial progress.

What, then, should a reasonable physician do? Certainly, risk tolerance and capacity for further work must be considered at this point. Many physicians elect to capitalize on surplus funds by further diversifying their portfolios with real estate investing. As someone who prefers less risk and desires more free time to be spent on family or long-lost hobbies, the idea of beginning a real estate venture or a similar process is completely unappealing. However, if you own a home, there is one real estate investment that makes sense and will almost always guarantee that you “beat the market:” Paying down the first half of your mortgage as quickly as possible.

Let me explain.

**The Mortgage vs. The Market**

Aside from student loans, which are typically higher in interest rate, the next most common debt is home mortgage debt. There are countless web articles that simply note the interest on a home mortgage is likely somewhere between 3%-5%, while the average annual stock market return is notably higher, around 8%. This leads many to the uninformed conclusion that investing that extra money into the stock market is more profitable than using it to pay down your mortgage to save that 3%-5% in interest. I would argue that this is a superficial analysis that gets turned onto its head when you consider mortgage amortization schedules.

**What Is a Mortgage Amortization Schedule?**

Let’s start back with the basics. When you purchase a home, you take out a loan from the bank. The bank charges an annual interest rate as a fee for this lending service. In this example, let’s say you purchase a home for $500,000 at 3.5% and get a standard 30-year mortgage. In simplest terms, you would pay 3.5% interest of the principal every year for 30 years. The principal payment would always remain the same, and your interest payments would decrease as the principal is reduced. Your total payment would be higher initially and then decrease over time. This is called straight-line amortization.

Unfortunately, it is not that simple, and this is NOT what banks do.

The disadvantages of straight-line amortization are that payments change on a monthly basis and that they are highest at the beginning of the loan. To counteract these negatives, banks created mortgage amortization. In this method, monthly payments are the same over the life of the loan. This means that interest fees are paid in higher proportion in the early years of the loan, while principal payments are weighted more highly in the later years of the loan. The result is that the customer pays the principal much more slowly at first, and total interest payments are higher over the life of the loan. While beneficial for the borrower to have consistent payments, mortgage amortization schedules were created with the lender’s profit in mind.

**More information here:**

How to Get a Mortgage with a Great Rate

**Is Paying More Interest in the Early Years of Your Loan a Problem?**

The result of a mortgage amortization schedule is that you end up paying approximately 15% more in total interest compared to a straight-line amortization. While paying more total interest is not ideal, the negative effects are further increased if you move before paying off your home. Think about it: how many people do you know who live in a home for 30 years these days? It’s very few, in fact. The average time spent in a home is only eight years, while the median is only 13 years. This results in a minimum amount of wealth accumulated as equity, while the highest amount of your money goes toward interest and lender profit.

After eight years, 60% of your mortgage payments would have gone to interest. Life and desires change quickly. Think back to when you were 20 years old. Did you guess correctly what your life would look like as a 35-year-old? I’m guessing not. Unless you live in your dream home, easily afford the payments, and plan to stay there for the remainder of your years, I would consider a closer analysis on the benefits of paying your mortgage early.

**Mortgage Amortization Schedule Breakdown**

When you look at a standard mortgage amortization graph offered by banks, it can get quite confusing. They typically have multiple lines representing very different data all on one chart. While well-intentioned, this makes it difficult to isolate the important aspect: total interest paid. Below is a standard mortgage amortization graph from our example home, with the total interest payments isolated. When you take a closer look, you realize a few things. As previously noted, your interest payments are initially quite high. There are also very subtle inflection points, where your interest payments will begin to decrease significantly. As the slope of the line approaches zero, meaning the line becomes more horizontal, your interest payments are approaching zero. The line placed at the 20-year mark helps demonstrate truly how little interest is paid in the final decade of your loan (orange area under the curve).

To simply state that paying your mortgage early will earn you the interest rate charged for the loan is actually quite inaccurate, depending on the portion of the loan being analyzed. You must compare the return on investment among different strategies to truly compare them fairly. The same principles of compounding interest earned in a retirement account apply to interest saved on a mortgage amortization schedule.

It is for this reason that I say every physician should pay their mortgage early—to own at least half of their home. If you pay off the first 20 years of your mortgage within the first five years, you are almost assuredly beating out any investment that you would otherwise pick, while maintaining the month-to-month flexibility of low required monthly payments.

In our above example, a $500,000 home was purchased at 3.5% interest rate for 30 years. The table below shows various amounts of interest and principal paid at various points during the loan.

What you can see is the numerical representation of interest payments being front-loaded and principal payments being back-loaded. Half of your interest is paid in the first 10 years of the loan, while only a quarter of your principal is paid in the same decade-long timeframe. Therefore, if you were to pay off the first 20 years of this mortgage over five years, you would have a guaranteed return on investment of approximately 10%. This is incredible, and it rivals even the best stock market returns. What’s more, when you consider this is only over a five-year period and you compare that to the short-term volatility of the stock market, it becomes increasingly likely that you will beat out any and all plausible stock market returns.

Additionally, the benefits will only increase as mortgage interest rates climb. Just as you can use historical data to determine stock market returns, you can also use historical data to estimate home mortgage interest rates. From the graph below, you can see the years where rates were less than 3.5% were truly remarkable, and they should not be counted on for future homebuyers.

**Should You Pay Off the Entirety of Your Mortgage or Just Half?**

As you approach the last one-third of the mortgage amortization schedule, your return on investment begins to diminish significantly. This can be exemplified by comparing the interest saved if you were to pay the first year or the last year of your loan early. During the first year, you would save $17,000 by paying it off early, which equates to an astounding return on investment of 180%. In the last year, you would only save $500 which is an ROI of a paltry 1.8%. Therefore, in the last one-third of the loan, it is increasingly wise to invest your money elsewhere.

In essence, this means you would pay your 30-year mortgage in roughly 15 years. For some, there can be emotional wins from completely eliminating debt, but by the numbers, this is technically not the most advantageous option. Some will argue that it would be wiser to simply get a 15-year mortgage and obtain a lower interest rate. This is certainly a valid argument, but for those of us with a lower net worth, erratic income, low starting equity, or many other scenarios, this does not afford the same flexibility that a 30-year mortgage does with its lower required payments. I, for example, am getting married in the fall of 2023, and I skipped three months of my extra principal payments to pay for the wedding. This is the type of flexibility I need at this point in my life, and I’m certain that anyone with a family or other source of unexpected expenses would agree.

**More information here:**

10 Ways to Pay Off a Mortgage Quickly

**Things to Consider Before You Pay Off Your Mortgage Early**

It is important to note a few caveats before using your surplus funds to pay down your mortgage.

- While your returns can be great, they do not trump the financial benefits of fully funding your 401(k)/IRA. You should only prioritize paying the first half of your mortgage after funding these accounts and having a student loan debt plan in place.
- Most home mortgages don’t penalize you for paying early, but it’s best to check the fine print first.
- When you do begin paying ahead, don’t recast your loan or the returns will diminish significantly.
- If ever refinancing, do not refinance for a period of time longer than your current position on the amortization schedule.
- And for those of you considering the tax implication in regards to mortgage interest deductions, the adage of spending more on your mortgage to save more on your taxes again does not hold true.

The net gain is always in favor of paying your mortgage early.

*[Editor's Note: While paying down a mortgage early in its term does save you a lot more total interest, the rate of return on extra payments early in the loan is precisely the same as the rate of return on extra payments late in the amortization schedule, it's just compounded over a longer period of time resulting in more money/less interest paid. That rate is the after-tax interest rate on the loan. That is the rate to use when deciding whether to pay off debt or invest. Be sure to also use the after-tax rate of return on the investment and to account for additional risk that often comes when investing instead of paying down debt. What this post is saying is that just like investing early in life is better because of compound interest, so is making extra payments early in your mortgage. Those payments then have a lot longer to compound, even if the rate at which they compound is the after-tax mortgage rate.]*

**If you're interested in pursuing other kinds of real estate investing and working with some of the WCI-vetted partners that Dr. Jim Dahle invests with, here are some of the best companies in the business.**

## Featured Real Estate Partners

*Does this kind of mortgage payment schedule make sense to you? If you could pay off the first half of your mortgage early, where else would you invest? What else could you do with that saved money? Comment below!*

*[Editor's Note: Dr. Zach Zemore is a graduate of a combined training program in Emergency Medicine and Internal Medicine who is currently expanding his personal and professional horizons in the big sky country of Montana. This article was submitted and approved according to our Guest Post Policy. We have no financial relationship.]*

Thank you for this post! First time home buyer here. Hypothetically, if I had $300k and wanted to purchase a $600k home, would it make more sense to put in a $300k down payment from the beginning

or

start with putting 20% down ($120k) and soon afterwards pay off the additional remaining $180k once the loan has begun?

I am inclined to think it is the same either way.

because fees for the mortgage are based on its size, you save more than the interest rate (the first year anyway) with a larger down payment and smaller mortgage. (origination fee and other named stuff). So that’s a bonus for using a larger down payment.

Good point Jenn. You also have more mortgage options and may be able to get a better interest rate by avoiding a jumbo mortgage or something like that.

Makes a bit more sense to have a larger down payment. Technically save a bit more on interest if you do it that way, all other things being equal. It’s also possible you could have lower associated fees if you take out a smaller loan to start.

The payments would be very different. If you just made the regular payments after that big lump sum, you’d pay the mortgage off sooner with your second option, but your payments would be much higher.

This was a well-written article that addresses a common question that people pose to themselves. Why pay down a mortgage at 3-5% interest when I can get 8% in the market historically. The author has demonstrated that this is not such an easy question and is more complicated than it appears. While reading the article I couldn’t help but think about how I handle mortgages, I ALWAYS finance over 15 years. If the payment seems too high for you, then you are buying too much of a house. While this strategy doesn’t solve all the problems being addressed with attempting to “own half of your home”, it sure makes things much simpler. Thank you for the article!

I’m a 15 year mortgage person also; but couldn’t convince my daughter to opt for that over 30 year. She said she wanted the flexibility of paying extra when she felt she COULD, not the requirement to do so, just like the author of this post. And has trimmed a good bit of the principal down over the years, just wasn’t certain that would always be the best option.

There’s a cost to having that flexibility/option, but it’s worth paying for many people.

I subscribed to the same philosophy when we finally bought our “doctor home.” 15 year we paid off in 7 then did a big renovation paid for with cash.

Maybe they live in HCOL, there isn’t a SFH in our area that is under $1mil. With 20% down and a 15-year fixed at 6.85%, the monthly payment would be ~$7000+property tax. When you’re a first time home buyer it is easier to stomach a monthly payment of $5700 on the 30-year fixed.

This analysis is ignoring the time value of money and that to measure returns on an investment you can’t only consider the total you receive but the length of time required to realize the return. For instance, when you write that paying off the first 20 years of a mortgage at 3.5% interest in 5 years gives you “a guaranteed return on investment of approximately 10%,” that is not a yearly return and it is not correct to think that this is competitive with another investment (like long-term equity returns) that gives 10% yearly returns. Each early principal payment has saved you no more and no less than 3.5% each year; the IRR for early repayment of a mortgage doesn’t change based on the date of making the payment and is simply the interest rate on the mortgage. I understand the desire to compare total interest paid on a loan over its lifetime but those total numbers are treating payments made today as identical to the payments made 30 years from now, which is not correct and especially distorts the analysis of a 30 year mortgage. For instance, $1 in 1993 bought about as much as $2 does today.

Yes, your criticism is accurate. The author did not adjust the ROI for the amount of time over which the return comes. While the interest savings is accurate, there is time value to the money used to get that interest savings.

Basically, paying down a mortgage always provides a rate of return equal to the interest rate of the mortgage. It’s the same rate of return whether you are making extra payments in year 2 or year 28 of the mortgage. But the cash flow is obviously very different once the mortgage is paid off and the time until the mortgage is gone varies by when you make the extra payments.

We should have caught this in the editorial process and had the author address it in the original post. Live and learn.

Thank you for clarifying. I would love to hear more about “time value” of the money used in paying off debt perhaps in a podcast or blog post. Thanks again!

Agree with the time critique in relation to time and ROI. Now if you set time to zero (i.e. buy in cash) does that mean you save 200k in interest the day you buy, or get that return over the next 30 years? Rhetorical question, but I suppose the subtext is, what are their benefits to non linear investing/saving?

Zach, your question essentially boils down to “what is the time value of money”. The short version is that you would save 200k interest over the timeframe of the loan, not all at once. If you want to know what that’s worth in today’s dollars you can use a present value calculation of all the future payments discounted over time at an appropriate interest rate.

If you buy cash today you will save interest over the years that you hold the mortgage (as well as initial fees and hassle) but you will also face the opportunity cost of doing something else with that money, eg paying off student loans or using the leverage to invest in the market. You’ll have too many good things to do with your money so there will always be choices. The trick is to make informed decisions based on your financial plan.

I disagree. If you make a large lump sum payment on a loan at the beginning, as the author mentioned, the savings on interest is immediate. By jumping the lines on the amortization table, those are interest payments you are not required to pay. If averaged over the 30 year loan, the interest saved would only add up to your applied interest rate on the loan. Being able to purchase a home with all cash isn’t only saving the 200k in interest, you would also not be paying a mortgage payment. So assuming no debt, all income could then be spent, invested, saved, etc.

Thanks! I knew this was incorrect someway but didn’t want to do the math to be certain I wouldn’t look the fool bringing it up. (Asked my bro the actuary to do it for me but he didn’t bite.)

How does one operationalize this information?

Example: I have a 30 year mortgage of $212K at 2.5%.

The principal is $921 a month. I pay an extra $200 on the principal every month, so I’m paying about 2.5 extra payments a year.

What does it mean, “pay ahead”? Give the lender a years worth of payments at one time?

About half of this potentially payable $212,000 is currently earning 4.1% in one high yield savings and another $132,000 is earning 6.5% in short term notes and supply chain finance. So this money is earning about 5.3%. The mortgage note is 2.5%. Seems better to keep the principal at 5.3%?

I read the article, but I still don’t fully understand how to use this information to “pay off the front half of the mortgage”. Pay $112K all at once?

This is the last year I will itemize, I think. My wages are half as much in semi-retirement starting in 2023.

had the same question. What’s the most mathematically advantageous way to pay off the first 20 years in five years?

You don’t have to make 20 years worth of payments to cut 20 years off a mortgage due to the time value of money. You only have to pay 20 years worth of principal payments.

I had the same question. Does anyone have spreadsheets or equations to do our own analysis? We bought a house last year with a 30 year 5.5% interest rate. We are in the fortunate position of being able to pay everything off right now if we wanted, but are debating whether something like the post suggests would be better – it would be great to be able to play with various scenarios.

Want a 5.5% guaranteed return? Then pay off the mortgage. Would you rather spend or invest that money? Then don’t. It’s really that simple.

Personally, at 5.5% I view that as a pretty good guaranteed investment. Other guaranteed investments are only paying 3.5%-4.5% right now pre-tax.

Knowing that everyones numbers are a bit different, the summary statement would be: if you are anywhere on the first 20 years of your 30 year mortgage amortization schedule, you should likely put any “extra” money such as you described from HYS, etc. to the mortgage. The ROI is actually much higher than 2.5% (mortgage rate) if it is in the first 20 of the 30 year schedule. Since the benefit comes from “compound savings” the sooner you do it, the more benefit there will be. It could be thought of similar to dollar cost averaging, whereas the benefit comes in getting you money in early. You just have to be OK with your money no longer being easily liquid.

“The ROI is actually much higher than 2.5% (mortgage rate) if it is in the first 20 of the 30 year schedule. Since the benefit comes from “compound savings” the sooner you do it, the more benefit there will be”

This is so misleading because if he keeps his money in an investment with a higher interest rate, that ALSO compounds.

You can’t take a 2.5% interest rate, calculate the money made / saved over 20 years as the “ROI” and then compare that number to the to 5-8% yearly interest rate from some other investment. You have to compare apples to apples.

As WCI mentioned, there is less guarantee in other investments, but even CDs have higher interest rates than mortgages right now and there is compounding there, too.

As proof, if you take the numbers from the article, 500k mortgage at 3.5% over 30 years – if you run a early mortgage payoff calculator paying an extra $10k a year, you’ll finish paying off the mortgage in ~18 years

Now if you run an interest calculator where you contribute 10k/year with the same annual interest rate of 3.5%, you will find that at this exact time in year 18, you will have enough to pay off the mortgage (~$250k)

Paying ahead is usually the wrong thing to do. Most pay extra money on the principal rather than making early payments. I believe that is what the author is discussing here.

Thank you for this post. Unfortunately, I am not following your math or description entirely. See quote below. Two questions:

1. “Paying it off early” – does this mean paying off the whole remaining mortgage? Just one year? 20 years of the 30?

2. The ROI of 180% is not clear to me. What would be helpful is a table or two equations to show how you got a 180% return vs a 1.8% ROI with the various scenarios. Thanks.

“Should You Pay Off the Entirety of Your Mortgage or Just Half?

As you approach the last one-third of the mortgage amortization schedule, your return on investment begins to diminish significantly. This can be exemplified by comparing the interest saved if you were to pay the first year or the last year of your loan early. During the first year, you would save $17,000 by paying it off early, which equates to an astounding return on investment of 180%. In the last year, you would only save $500 which is an ROI of a paltry 1.8%. Therefore, in the last one-third of the loan, it is increasingly wise to invest your money elsewhere.”

I disagree with the conclusion for reasons eloquently stated above by PharmMedMD. The ROI calculation the author has made is an unusual way to look at the situation. I wouldn’t necessarily call it wrong, just not adjusted for time really.

I’m not sure why you let this post run, Jim. As others have mentioned, the math presentated is misleading. It DOES come down to risk tolerance and the author is making it way more complicated than that.

Did you read the rest of the comments? We all get in a hurry sometimes.

I’m actually glad so many readers noticed the problem with the post, it’s a sign of financial literacy because it’s relatively subtle and comes down to the definition of return.

Let’s remember the Man in the Arena quote at times like these:

“It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.”

Dr. Zemore is the man in the arena. He stumbled a tiny bit with this post. I stumbled a tiny bit with it not catching the error before it ran. Try not to pile on too much.

The really nice thing about blogging, especially with a big educated audience, is you can fix errors relatively rapidly because they get pointed out so readily.

I wish we had a “like” button on this part of the blog because I wholeheartedly agree with that “man in the arena” observation.

Amen.

Let’s not bash the author or the editorial process. An asterisks or a comment at the end of the post that points out the mistake is all that’s needed. The comment section kept us all honest but for those that didn’t read the comment section, this subtle but critical caveat is an important lesson IMHO!

The anonymous internet commenters don’t understand how hurtful criticism can be. I’ve developed a fairly tough skin over the 12 years I’ve been doing this, so little bothers me anymore but it can still get to me. I’ve had columnists who wanted to quit over comments but they also get more used to it over time. We had a whole discussion about it at the columnist panel at WCICON. But a guest poster that gets met with these sorts of attacks with a first piece that obviously had a ton of effort put into it? That’s got to be painful. And I feel terrible about it because if I’d made one tiny suggestion prior to publication there wouldn’t be any of it.

Love this man in the arena reference. I understand the criticisms but still learned something about amortization. Thanks to the author for writing and sharing.

Same question. I have 3 % interest rate. I have about 350k loan left. I have basically paid minimal principal in year 1. It’s 1/3 pricinipal 2/3 interest from my stub I receive from bank. If I assume after taxes my return for stockmarket taxable account will be similar which one is better. I have assumed it was 3% benefit by paying against the loan so I was not going to touch it.

Your assumption is correct. Paying down a loan provides a return that is the equivalent of the after-tax interest rate on the loan. It is risk-free and so should be compared to other risk-free investments available to you.

An interesting lens to view this through. Rather than looking for how I can minimize interest, I look at how to maximize the growth of my next dollar over time. My dollars invested early will also compound more with exponential growth down the road whether via interest-saving or investing. The big advantage of real estate (whether personal or investment) is easy access to leverage and a disciplined repayment plan with less “visible” volatility to make you misbehave. By paying down the mortgage quickly, I am deleveraging and there is opportunity cost for the money trapped as “home equity” rather than in the public markets which are historically higher risk/return over long time frames. Take away the leverage factor and long-term home equity growth is historically just above inflation. The other disadvantage (in Canada at least) as a self-employed business owner physician is that I would need to hammer my mortgage with personal dollars. That means a much higher tax bill due to our progressive tax system compared to if I were to smoothly take money out of the business, pay personal tax in lower brackets, and pay it off. I can leave more invested via my corporation instead.

I still agree that there are advantages to paying down a mortgage aggressively. It is risk-free return and a decent one at current rates. It is also psychologically good (and a good use of money is to provide security). The other nuance (in Canada) is that mortgage interest is not tax deductible. However, if I pay my mortgage down or off and then refinance or take a mortgage and invest the dollars to earn income, the interest is 100% deductible against my personal income (54% top rate in much of Canada). That minimizes the amount of home equity dragging and keeps as much money on the fastest long-term train as possible. So, sequence is important here. Later in life, we also have much more financial buffer to be secure in our home (even with a mortgage on it).

-LD

Mortgage interest isn’t deductible but if you refinance it becomes deductible? Really? That doesn’t seem right.

I didn’t explain it very well. For us, mortgage interest on personal real estate is not deductible. However, let’s say I paid down my mortgage by $200K and then re-mortgaged for the original amount (or more if the property went up in value). I can take that $200K and invest it via a personal taxable account that pays any kind of dividend or interest (even less than the mortgage interest rate) and that makes it functionally a business loan to earn income. So, I can write off the interest of that portion of my mortgage against my total income.

So, if I had $200K of my $400K mortgage invested, then half the interest would be deductible against my personal income. We did that with a refinance once and more recently did it as a new mortgage after being mortgage-free for a spell. It is a bit of a pain in that you must track the money coming in, how you invested it, and track the interest paid. It was much easier more recently, when we took a new mortgage and invested the whole thing in one ETF. However, for us it was worth it. If I am in the highest tax bracket in Ontario (54% at >$230K CAD), then that makes the effective interest on the loan very low and easy to beat with a long-term investment. We actually used it as a way to income-split on top of that which made it even better to build assets in my lower-taxed wife’s name. We always get taxed on individual rather than household income.

I am not sure if there is an analogous situation there in the USA.

-LD

I don’t understand how it becomes a business expense if you’re borrowing against your personal home to invest in personal investments. I agree that if you used the borrowed money to start a business (such as a real estate rental business) you could then deduct it. I suspect that’s what you’re talking about.

But hey, Canadian law is not exactly the same as US law. Seems like an awfully big loophole though.

Business is perhaps a misnomer. Mortgage interest on the home isn’t deductible in Canada. Interest incurred to earn income is deductible. So a clever lawyer named Smith figured out a way to convert home mortgage interest to be tax deductible and fought for it all the way to the top of the courts. It is a mighty big loophole known as the Smith Manoeuvre.

Yep. Definitely a real thing here. I wrote about it on my blog a couple of times, but here is another link from a tax site.

https://www.taxtips.ca/personaltax/investing/interest-expense-on-money-borrowed-to-purchase-investments.htm

All that matters is that you pay the interest and expect to earn some income from the investment (regardless of what it is) and it is in a tax-exposed account.

It is actually kind of hilarious. We could deduct 5% interest from our income, invest it in QQQ and earn 1% dividends and the rest as capital gains (deferred tax at half the usual rate). Or get some Canadian eligible dividends that are also taxed favorably. Still, we need some tax breaks up here and by investing, we are helping to fund the capital markets.

-LD

You should send in a guest post from time to time with cool stuff like this from the Great White North eh?

I definitely plan to do exactly that! I just got back to writing after a couple years of hiatus due to my clinical/admin job and a lot of residency education work.

-LD

There is something called interest tracing that many CPAs have been very creative with. Perhaps worthy of a post.

Interesting stuff.

https://www2.deloitte.com/content/dam/Deloitte/us/Documents/Tax/us-tax-deloitte-2020-interest-tracing-guide.pdf

I am not against paying down or paying off one’s mortgage. However, this post is largely based on an incorrect premise.

Paying extra on a mortgage is ALWAYS mathematically identical to investing at your mortgage rate. The key point is this: you are investing at the mortgage rate for the remaining term of your mortgage. If you have a 30-year mortgage at 4%, and in the first month you pay an extra $100, then the benefit you receive is identical to investing $100 at 4% for 30 years. If you only have 10 years left on your mortgage, then paying an extra $100 is identical to investing at 4% for 10 years.

Thus, it is the duration of the investment that changes based on where you are in the amortization schedule, not the rate of return.

Agreed.

awesome article man!!! well done but yes I have to agree with PharmMedMD and other commentors above that if you look at time/value of money and the biggie currently, inflation and rising interest rates, a fixed rate mortagage just looks better and better in favor of not paying the mortgage off early. Dude last year inflation was calculated at one point to be 9.1%!!!! My mortage debt is being inflated away!

Also, definitely agreed that making extra payments early can dramatically decrease how much you pay overall for the life of the mortgage, but that’s because you are just decreasing the amount you are borrowing over the life of the mortgage. basically a mortagage is a bond and when you prepay it’s almost like you are forcing the bank to “call” part of the bond capital. The interest rate stays at 3.5% in your example but on a lower amount of principal when you prepay your mortgage. so if I have a $1.1 million mortgage for 30yr fixed at 3.5% and after one year my principal is now paid down to $1million, I now have a $1mil 29yr fixed mortgage still at 3.5%. Then I make a 100k prepayment as well, now its a 900k 29year fixed mortgage still at 3.5%. So in the end, I am paying less overall for the life of my mortgage, but the interest stays the same and its the principal that the mortgage is based on is what you are lowering.

given current high inflation and interest rates I would really argue against prepaying your mortgage if you have a low fixed rate mortgage. Banks would love to call these mortgages if they had the abilty to so they could take that money and invest it at higher mortgage interest rates. I agree on the pscyhological benefit for paying down debt. for myself, psychologically its reversed given my personality. it doesn’t bother me to have my $850,000 mortagage at 2.9%. I am comfortable with that debt. I would hate myself to prepay some of that 2.9% when I could have invested that prepayment in my high-yield savings account at PNC that makes 4%! So prepaying my mortage and eliminating the debt would really anger me that I am not being optimal with my money given I can make more “investing” in a savings account!!! I could see all my math teachers from my high school looking at me in disappointment!

so great article man but really in the end prepaying a low fixed rate mortgage is for the psych benefit of paying less overall for the life of the mortgage and having that sense of getting debt free. Prepaying the mortgage to come out ahead and using your money optimally in this rising interest rate and inflationary environment would not make sense.

This point (and the point of misleading ROI) should be emphasized.

I worry this article is misleading for people who dont thinking critically about the numbers proposed. TWCI should correct it if they agree this may be misleading, or clarify or add an addendum. People generally trust the posts here and may not look at the comments.

Another reason to pay off ones mortgage is to decrease ones sequence of return risk if close to retirement. It will eliminate your fixed costs. This, as many others have suggested, makes it again akin to bonds.

Most young investors may want to consider “lifestyle investing” which is essentially using leverage. The idea is proposed by a Yale Economist and involves leveraging early in life and considering your future working potential as a bond so you can minimize your time period risk. One can think of a mortgage as a form of leverage at a fixed rate to allow for more equity investing. More here: https://www.goodreads.com/book/show/7603406-lifecycle-investing

Maybe it’s worth adding a note in the post itself instead of just the comments below. I’ll think about that.

As far as “lifestyle investing”, that’s just a new name for a concept that’s been around for a long time (consumption/lifestyle leveling). I think it’s a terrible idea personally. I think people are much happier with a gradually increasing standard of living. The math works out a lot better that way too.

The idea of using leverage in your life is not unreasonable as I’ve written before, but most who come to this website in early career are way beyond recommended amounts of debt to do that properly.

https://www.whitecoatinvestor.com/the-value-of-debt-in-retirement-a-review/

We should all be very cautious of the too-good-to-be-true promise of debt getting “inflated away”. Bear in mind that your debt is only getting “inflated away” if your income is also getting inflated up (or maybe if your investments are getting inflated up). Are you guys getting your jobs or investments paying you an extra 9.1% per year? If so, good on you!

Inflation is not defined as an increase in real or nominal incomes nor extraordinary market returns; inflation is an increase in costs of living. If your income doesn’t keep up with inflation then you will just have fixed debt service + increased COL = reduced discretionary income. If all else were equal, high inflation should encourage you to reduce fixed expenses in order to protect your discretionary income.

Nevertheless, if your mortgage is vintage 2020 with a 4% on your savings, you obviously don’t want to throw cash at your mortgage right now. Whereas if you just bought recently and have a >6% interest rate, paying off the principal with a guaranteed return of >6% for every year you hold the mortgage is hard to beat.

very true! you are right, even though I am paying my debt with less real dollars it is all relative that my income is also keeping up with my personal inflation rate. I am not really changing my plan, but rather stick to it despite higher inflation. before inflation shot up, I did not want to pay off my debt given such low interest rates, and I am sticking to my written financial plan.

This article is a swing and a miss and I’m surprised it was published. I realize it is a guest post, but the conclusions are wrong and based on faulty reasoning as elucidated in above comments. I would suggest WCI post some clarifying comments at the end, otherwise people who don’t read the comments may be misled.

Boom. Roasted

As I mentioned in a comment above, the conclusion slipped through the editorial process and I’ll take responsibility for that. Considering adding a comment to the post itself.

Adding an editors note even in the middle of the article would help – I almost didn’t finish because I was like “this is ridiculous”

I’m not sure I can make you guys happy. I put in an editor’s note and now the complaint is “you didn’t put the editor’s note in the right place.” I think the post is very useful, I just think the conclusion needed to be slightly tweaked to make it 100% accurate. Instead of saying “You get a better rate of return by paying extra on a mortgage early”, it should have said “Your extra payments have longer to compound when you make them early in the mortgage.” Just like you should invest early in your life, you should pay off mortgages early on.

I will not further pile on for comparing the annual mortgage rate to the annual investment return. I’ll just note that the mathematical advantages of early payments will be the same whether you are paying the first half of your mortgage, or the first half of the second half of your mortgage. The question is really one of risk management and how much you value the guaranteed return of paying down the mortgage versus the more volatile potential after-tax return of investing. I did pay mine down early but that was to reduce the risk at the cost of losing higher returns.

I’m glad I can back to read all the comments.

Based on the comments, it makes little sense for me to pay more on my 2.5% mortgage with money that is currently earning an average of 5.3%. However, the short term notes and supply chain finance monies are not risk free.

The risk free 2.5% is not as good as the risk free 4.1% of a HYS account, even after paying marginal tax rates, but that money is fully liquid.

I’m also not going to run into a discretionary income challenge making a $921 payment.

No wonder the original premise didn’t quite ring correct. It wasn’t correct.

[Rude comment deleted]Hi,

Thank you very much for this thought provoking post. I’m still trying to understand the math, and I may just have my terms wrong. Part of it is because I’m confused by your use of ROI in the discussion of a loan that you’re paying back. May you explain a little more the “10% ROI” obtained by paying the first 20 years off in 5 years? Is that a “15 year ROI” for the remainder of the loan? How exactly are you thinking about this? If my loan is 3.5% APY, how can I save more than 3.5% per year by paying it back? Over what time period is your ROI being obtained? Thank you very much for your time and thoughts.

Alex

Yes. The ROI calculations in the original post are not annualized. That’s the beef numerous commenters have with the post (see numerous comments above). You won’t save more than 3.5% per year on a 3.5% mortgage. But over time, that 3.5% a year adds up.

Just a clarification about recasting – can you describe more completely why that would not be a good thing as this was part of my plan after paying a large chunk to have lower monthly payments? Does this reset the amortization schedule?

Thanks.

Yes, recasting resets the amortization schedule. You would get lower payments but not pay it off as fast.

This doesn’t take into account inflation- 4k/month now seems like a big deal, but that’ll probably be nothing in 30 years.

The assumptions used was a $500K mortgage at 3.5%. Payoff the first 20 years in 5 years. It should beat the stock market earning 8%.

In order to payoff the first 20 years of a mortgage in 5 years, you’ll have to make extra principal payments of roughly $3,375 per month (on top of $2,245 payment).

If you do that, your mortgage balance is $227,537.23 after 5 years. This is equivalent to your mortgage balance after 20 years the normal way ($227,052). That’s how I was able to solve what the extra principal payments would be.

Interestingly, I found doing accelerated payments of $3,375 a month for the first 5 years turns a 30-year mortgage into exactly a 15-year mortgage.

So, what you have after 15 years is a paid-up house. Again, forget appreciation as it’s the same on both sides of the equation. You move after 15 years because he says we never stay in a house that long.

Under normal conditions, after 15 years you have $186K ($500K – $314K) of equity….just as the article says.

But when you invest $3,375 a month after 5 years, earning 8%, that turns into $247,984. Then you invest $247,984 for 10 years (no payments). After 15 years, it’s worth $535,380.

So, you have $535,380 + equity of $186,000 = $721,380 vs. $500,000 or a $221,380 difference when paying the mortgage the normal way and investing the difference.

The $535,380 value has a tax basis of $202,500 ($3,375 * 5 years)…..likely higher as there was some taxes you might have needed to pay along the way……but it’s likely the higher interest payments allowed you to itemize and provided you better tax benefits than the standard deduction.

According to investopedia (FWIW), return on investment does not take in to account a holding period or passage of time. Therefore, it will miss an opportunity cost of an investment. If you create an amortization table for yourself using the values I have chosen, $1m for initial balance, 5% rate, 30 year term, 12 monthy payments. The monthly payment should be $5368.22. Assuming before your 1st payment is due, you are able to immediately spend 20k towards the principal of the loan. This would knock your balance from $1m to 980k. This immediately saves you approximately $66,054.05 in interest payments. Using the return on investment formula of ((current value of investment – cost of investment)/cost of investment) you would have a return of 230%. As the author mentioned, the further you get along with payments and the majority of your monthly payment becomes principal, the returns would decrease. Taking it out to payment 171, that same 20k payment would save you approximately $23,086.44 which is still a ROI of 15%

I understand the convenience of 30yr mortgage but still seems like much more interest is saved if doing 15yr from the get go vs 30yr and trying pay of 20yrs worth in principal the first 5 years?

I’ll agree with the other commenters that criticized this and add some sloppy math to back it up:

https://docs.google.com/spreadsheets/d/e/2PACX-1vQExfmlrcXTjS0QpxE7JVHXubKd77Av3mxsDeBAmbOXIEPIRaWcuvXw6de5qGp_LGwMlhCdJncA0HgG/pubhtml

It seems to me that if you compare the opportunity cost of paying off half the mortgage immediately, your total value at the end of the original loan period is roughly the same. I’m open to criticism if anyone notices errors in the math.

Dr. Zemore, good luck with your engagement, and after you are married be open to the possibility you bought the wrong house. I regard my home as a consumption expense that over the long haul can be a store of value rather than an investment, and so a mortgage was simply a means to pay for it. My experience has been that when my wife and I got on the same page about it, paying it off together (and celebrating it) was actually fun. Same with our second home. Also, don’t discount the psychological and spiritual benefits of putting that debt in your rearview mirror, keeping your windshield (and time) clean for the next thing rather than completing past transactions.