Why We’ll Carry a Mortgage into FIRE

In the pursuit of financial independence, one has to have a clear and realistic budget. For many, housing costs are the biggest budget category. This is also the case for me and my family. Our home mortgage, property taxes, and home insurance make up about 35% of spending. That said, it’s worth considering ways to reduce costs in this budget category. And paying off the mortgage would definitely reduce costs – at a price.The typical debate over whether to pay off a mortgage has two main factions:

  1. The interest rate on a mortgage (3-5%) today is well below historical stock market returns (8-10%), thus paying off a mortgage early isn’t the best financial decision.
  2. The peace-of-mind of paying off the mortgage outweighs any financial gain that could be achieved.

I think both of these factions have great points. It’s why it’s almost universally accepted that home debt is “good debt”. The interest rate tends to be below what one could earn on an investment. But there’s something deeper in the peace-of-mind argument that might be internalized – sequence of return risk is reduced with no mortgage payment.

Let’s look at cash costs of a fairly typical mortgage today. $200,000 borrowed on a 30-year, fixed-rate mortgage with a 4.0% interest rate. The payment on this loan would be $954.83/month or $11,457.97/year. Thus, the cash cost of the mortgage is 5.73%.

At a 4.0% safe withdrawal rate, we’d need to have $286,450 invested to cover the mortgage payment. That’s a difference in amount borrowed vs. invested of $86,450!

As the principal gets paid down, the cash cost of carrying the mortgage increases. Thus, it may be a prudent move to pay off a mortgage – despite the headline interest rate being well below what one can reasonably expect to earn on investments.

I ran an example of someone with $250,000 in cash that could either buy a $250,000 house outright or borrow $200,000 to buy the house and invest. The person who buys the house in cash gets to invest the other person’s mortgage payment. At the end of 30 years, taking out a mortgage leads to higher net worth:

Year 1 Mortgage No Mortgage
House Value                      250,000                      250,000
Mortgage Balance                      200,000                                –
Mortgage Payment Value                                –                                –
Investment Balance                      200,000                                –
Net Worth                      250,000                      250,000
Year 30 Mortgage No Mortgage
House Value                      452,840                      452,840
Mortgage Balance                                –                                –
Mortgage Payment Value 1,297,995
Investment Balance                2,012,531                                –
Net Worth                2,465,372                1,750,836

We spent quite a bit of time debating this in our personal life, and have tended to believe that not paying off the mortgage is the better choice. The cash cost savings was tempting, but higher wealth over time won out.

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