House Poor: On the Wisdom (or Not) of Early Mortgage Payoffs
Recently, I had a discussion with an acquaintance regarding marital finance. My acquaintance stated that if her future husband earned an income similar to hers, that she would suggest living on one paycheck and use the other to pay off the house in five years, so that there would be “one less bill to pay.” Though it may seem counterintuitive, I think that there are more effective uses of this or any homeowner’s extra income.
Paying off a house places the majority of most people’s net worth in an asset that is difficult to liquidate. If you ever need the money you’ve spent on your house, you have to take a mortgage on the property or attempt to sell it, which can take more time than you have, especially in the case of a sudden medical need or similar event.
Low Mortgage Rates and Changing Notions of Home Ownership
For most people, a house is the largest asset that they will ever own and the one that carries the largest liability. What many homeowners don’t know is that their homes are also potential wealth generators. I’m not arguing that everyone should stop trying to pay off their house or trying to eliminate large bills; the latter especially is a wise choice. I’m also not arguing that there aren’t people for whom paying off a mortgage early makes sense. What I am arguing is that people should use their homes holistically, especially now that equity is subject to a real estate market that is less reliable than in the past. Furthermore, most of us don’t plan on living in the same house for 30 years, so paying off the house is not as much of a priority as in previous generations, when people were more likely to live in one home for their entire adult lives.
The financial environment has also changed. The current lending environment has created historically low rates which almost makes the money free.* If a couple decided to live off of one paycheck, they could consider placing the funds in an investment that returns 10% interest a year. Assuming they were paying a 3% interest rate on the mortgage, they would have a net earning of 7% on their money in one year. In my opinion, this would be better than placing all of their extra paycheck into house payments.
The “secret” to building wealth putting your money to work. Before the housing boom, homes were considered one of the safest investments because the assumption was that they would continue to appreciate. After the 2008 financial crisis and the collapse of housing markets, it is clear that this is no longer the case for everyone, if it ever was. Given the new reality, a more effective strategy may be to diversify assets and try and earn as much interest as possible. Ways to do this include 1) getting the lowest possible rate on your mortgage, 2) saving taxes by deducting mortgage interest and property taxes, and 3) saving as much cash as possible to invest in other assets.
What you think? How does your home fit into the mix of your financial health?
* Note the almost. There is, of course, no such thing as free money. Even an interest-free loan requires that you pay it back.