Long-term readers know that we're not really big on debt. We worked our way through undergraduate. I avoided medical school debt by signing four years of my life away with the military. We also don't buy cars on credit or carry balances on credit cards. We pay extra on mortgages and prefer 15 year mortgages to 30 year mortgages. But technically, I have not been debt free since I was 18, almost 24 years ago, due to some debt or other. Recently that changed.
Our main (okay only) debt the last few years has been our mortgage. In October 2010 we bought a house for $482,000, putting 20% down and taking out a 15 year fixed mortgage of around $386,000 at 3.375%. We refinanced a couple of times as rates dropped and eventually ended up with a 2.75% mortgage, which is mostly deductible to us leaving us with an effective mortgage rate of something like 1.6%, a little less than inflation. That very low mortgage rate, the availability of much more attractive investments (usually in tax-advantaged accounts), and significant need to take risk to reach our goals kept us from routinely throwing extra money at the mortgage. However, over the last couple of years as we have loosened the purse strings and started spending more, we have looked at that mortgage with more and more disdain. Since money is fungible, in effect, we are borrowing against our house to buy wake boats, brand new cars, fancy bicycles, trips to Belize, and heli-skiing adventures. We're really not okay with that.
Paying Off The Mortgage Early
So we have decided to pay off the mortgage early. At first, due to the obvious arbitrage opportunity between borrowing at 1.6% and investing in the markets we simply started a taxable investing account and called it our mortgage pay-off fund. That works out well for us as we claim any tax losses against our regular income and then use appreciated shares for our charitable contributions. Given stock market returns the last couple of years, we have come out ahead doing that. However, we have been fortunate to have seen not only our income but also our net worth climb dramatically the last couple of years. At the end of 2016, having already maxed out all of our significant tax-advantaged space, invested a sizable amount into a taxable investing account, increased our charitable giving, and blown plenty of money on fun stuff, we still had a lot of cash sitting around. So we sent it to our mortgage lender. Prior to that check, our mortgage was down in the $275K range. The check was $138K, precisely the cost of our first post-residency house and about half of what we owed. The next month was also a good one here at WCI, so we sent them another $40K check, which brought our mortgage down into the high five figure range. Theoretically, our mortgage was now paid off, since that taxable account was sitting at $152K and the mortgage was now only $97K.
Well, the year came to an end and all of a sudden we had tax-advantaged space to invest in again. So now our extra earnings would start the cycle again. First the Backdoor Roths and the HSA. Then the 529s up to the state deduction limit. Then the 401(k)s and at the end of March the defined benefit/cash balance plan for 2016. Lots of tax payments are due in April (remainder of 2016 taxes, quarterly estimated for 2017, 2016 state taxes) but by May we had maxed out the 401(k)s and were left with the decision of investing in taxable or paying off the mortgage. So we sent in a check for the remainder and now we're debt-free!
Why We Paid Off Our Mortgage Early
So why did we do it?
# 1 The Borrower is Slave to the Lender
Proverbs 22:7 says “the rich rule over the poor and the borrower is slave to the lender.” As blog commenter Csciora pointed out a few months ago,
Why settle for a 30 year mortgage when a lifelong mortgage would seemingly provide the same benefits? It should be an even better deal. What you haven’t mentioned is the decision to borrow money in the first place (indebtedness) is simply a decision – not a requirement. There are certainly ways to own a car, receive a high-level degree and even own a home without acquiring debt.
Prior to around 1940, the concept of a mortgage didn’t exist. You saved enough cash and/or built your own home. The idea of borrowing money for “basic” living expenses is a modern concept. Only a few decades later, most people have decided that borrowing to finance their lifestyle is both acceptable and necessary. I just saw an article saying the average new car financing is over $30,000 with a typical loan payoff of 68 months. That’s entirely due to marketing, not necessity.
My point is analyzing the benefits of financial arbitrage on big-ticket items entirely skips past the idea of simply buying them outright in the first place. Debt carries far more baggage than simply numbers in a spreadsheet.
While technically the average mortgage length increased from 5 years to 12 years during The Great Depression and the 30 year mortgage is a product of the VA loan for returning WWII GIs, the fundamental truth remains that when you owe something to someone else, you have promised them some of your future life energy/earnings/income that could be used for something else if you didn't owe the money. The value of your debt is remarkably stable when compared to income and assets, both of which can fluctuate greatly due to unforeseeable future events.
Not to mention, how fun is it to deal with a lender? I routinely hear complaints from docs about the run around their lender gives them. Guess what? If you don't owe money, you don't have to deal with those guys at all. That's worth something.
# 2 Meet a Goal
One of our financial goals was to have a paid-off house. Check! It might not be your goal, but it was one of ours and we reached it much sooner than we expected. I think we can be justifiably proud of that.
# 3 Free Up Cash Flow
Our P&I payment was $2500 a month. Now we can use that for something else. In addition, this lowers our fixed expenses and thus our need to replace that income in a financial independence/early retirement scenario. $2500 a month = $30,000 a year. At a 4% withdrawal rate that lowers our necessary nest egg by $750,000. At a 3% withdrawal rate sometimes used by conservative very early retirees, that lowers our “number” by $1 Million.
# 4 Lowers Our Need For Life and Disability Insurance
I no longer need enough life insurance to pay off the mortgage. Nor do I need enough disability insurance to make the payments. Little by little, step by step, I am getting closer to being able to cancel these temporary insurances and save the premiums. [A subject for its own post, but we'll probably carry them another year or two.]
# 5 We're 8 Years Into a Bull Market
The average bull market is 97 months. We are now 98 months into this one. My crystal ball is cloudy as always, but it seems likely we're closer to the end of it than the beginning. The further we go into this bull, the better a guaranteed return, even at 1.6%, becomes. If the market tanked tomorrow and I hadn't paid off the mortgage, I would have regretted it.
# 6 Our Deductions Are Getting Phased Out
Low earners often don't get to fully deduct their mortgage interest because only the amount above and beyond the standard deduction is really deductible. Likewise, very high earners start running into the Pease phaseouts (FYI these no longer exist since 2018) which also limit how much mortgage interest can be deducted. Our income hit that range for the first time in 2015 and we're losing more and more of it each year. [Purists would correctly argue that the Pease adjustments are really just an additional 1% stealth tax bracket.]
# 7 Our Need To Take Risk is Dropping
As we rapidly approach our financial independence “number” our need to take risk drops each year. That includes leverage risk, i.e. borrowing against the house in order to invest. As Bernstein has said, when you've won the game, stop playing.
# 8 The Leverage No Longer Has A Significant Effect
When we first took out the mortgage, our net worth was less than a million dollars. Borrowing that $400K instead of liquidating our investments actually had a significant effect on how quickly the investments grew. As the mortgage has fallen and our assets have grown, the ratio of investments to borrowed money has fallen so far that the leverage doesn't have any significant effect on our investments any more. For the same reason I don't take $5K 0% credit card offers and invest the difference like I might have a decade or two ago, I don't need to borrow a few hundred thousand against the house to invest any more. It simply isn't worth the risk and hassle to me.
# 9 Because We Can
Thanks to education, hard work, smart financial decisions, and a little luck, we're in the position where paying off our mortgage early (<7 years) is not only possible, but possible without doing anything extreme like eating ramen, reusing paper towels, or skipping retirement account contributions. We recognize that lots of people aren't in that position, but we are, so we will. It just seems silly to be a multi-millionaire and be carrying around a five or low six figure mortgage. Now nobody can ask me “If you're so rich how come you're still in debt?” We can afford the luxury of not having to maximally leverage our life to reach our financial goals.
# 10 To Teach Our Kids Debt Can Be Temporary
I don't necessarily have a problem with the responsible use of debt. I think it's okay that most people pay for medical school with a reasonable amount of debt and buy a reasonable amount of house using mostly borrowed money. But as you know, there are many people who don't use debt responsibly. We wanted to show our children that being in debt is a temporary condition, not a lifelong requirement and perhaps inspire them to also obtain a debt-free life. The kids all want to go on the Dave Ramsey show and do a debt-free scream, but I don't think Dave is really looking for people in our situation. Besides, we still run our monthly expenses through credit cards, which Dave obviously doesn't approve of. So we'll just do that debt-free scream right here on this site!
So, how does it feel? I confess I don't have some overarching sense of accomplishment from paying it off. I feel the satisfaction of meeting a goal and of knowing my family's lifestyle is a little more secure in case something happened to me and my income than they were before. But we were pretty financially secure before that check was written and the amount of objective additional security we have obtained is somewhat minimal when looked at logically for most anticipated futures. But I certainly don't plan to go get another mortgage or HELOC.
What do you think? Do you plan to or did you pay off your mortgage early? Why or why not? How did you feel afterward? Did you go back into debt afterward? When do you think the typical doctor should pay off his mortgage? Comment below!