6 Reasons the Rich Should Pay off Their Mortgage Early

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I’ve thought a lot about this topic and as of the moment, I’ve made the decision to take my time paying off my mortgage. That isn’t to say I won’t change my mind anytime soon. Where do you stand on the topic?

Today’s Classic post is republished from The White Coat Investor. The original post can be found here. Enjoy!


[WCI’s Note: This was inspired by Stephen Nelson’s 2014 post Why Early Mortgage Repayment Makes Sense for High-Income Investors. It seems appropriate to mention something about standing on the shoulders of giants with this blog as much of what I write about has been said before in other ways and other places. At any rate, today we’re going to be talking about paying off your mortgage early. Regular readers know I have mixed feelings (and an update) on this topic, of course, and this post is pretty much written from just one perspective. Remember it’s titled “6 Reasons the Rich Should Pay Off Their Mortgage Early” not “YOU Should Definitely Pay Off YOUR mortgage early.”]

Most Americans have a financial goal to have a paid-for house. Many would even like to pay the house off in less than a standard 15-30-year time period. However, the truth is that most Americans probably shouldn’t be paying off their mortgage early. This is because they usually have a better use for their money. On the other hand, it is far more likely to be the right move for a wealthy, high-income professional. This article will detail six reasons why.

6 Reasons the Rich Should Pay off Their Mortgage Early

1. Compare to a Taxable Account

Joe Average has a household income in the $50,000-100,000 range. He is almost surely not maxing out a 401(k) ($18,000 employee contribution if under 50) and a backdoor Roth IRA for himself and his wife ($5,500 each). That would require a 29-58% savings rate, which is extremely rare at any income, but particularly for the middle class. Thus, if he chooses to pay down the mortgage with his extra funds, he is by definition passing up the opportunity to have tax-protected growth for decades, an extremely valuable benefit.

A high-income earner on the other hand, especially one who saves enough to now be wealthy, is probably maxing out all available tax-advantaged retirement accounts. So when he considers paying down his mortgage, he is comparing that to investing in fully-taxable, non-qualified investing account, which is not nearly as good a deal.

2. Higher Tax Rates

Even if a low earner is investing in a taxable account, he may pay very low taxes on those earnings. If he is in the 10% or 15% bracket, he pays a rate of 0% on his long-term capital gains and qualified dividends. A high earner, however, is paying at least 15% on those earnings, and possibly as much as 23.8% (not including state income taxes.) This lowers his after-tax return such that his mortgage starts looking even more attractive.

[Update July 2018: This becomes even more significant now with the higher standard deduction, as most people, including many high earners, are no longer itemizing their mortgage interest, raising the after-tax yield on paying off the mortgage.]

3. Lower Marginal Utility of Extra Wealth

Many advisors recommend carrying low-interest rate debt on purpose so you can invest instead and hopefully earn a higher rate. Aside from the obvious error of not comparing apples to apples risk-wise (they should be comparing the after-tax mortgage interest rate to the after-tax return on a very safe investment such as treasury bonds, CDs, or a municipal bond fund), they are ignoring the marginal utility of wealth.

When you are very poor, a little more wealth makes a huge difference in your life economically and psychologically. As you build wealth, that difference gets smaller and smaller. So for a wealthy high-income earner, arbitraging a low-interest rate against a higher return is simply less useful. Many times these higher earners choose to lower their risk rather than increase their returns.

4. The Ultimate Luxury Good

Many times the wealthy buy something simply because they can and they enjoy the extra bit of luxury it affords. That might mean flying first class, driving a Lexus instead of a Toyota, or carrying around a Birkin bag. A paid-off home can also be a luxury good. The wealthy simply don’t have to leverage their home in order to reach their financial goals, so they choose not to, because they can. As debt-elimination guru Dave Ramsey likes to say, “The paid-off home mortgage has taken the place of the BMW as the status symbol of choice.”

5. Deflation Protection

A fixed-rate mortgage provides inflation protection. If inflation goes up, it becomes easier and easier to pay that debt. However, a mortgage is a big risk in a deflationary scenario. All of a sudden you are paying that debt back with more and more valuable dollars, all while your income is dropping.

The wealthy are likely to have better inflation protection already in place than the middle class. These may be investments such as stocks, real estate, I bonds, and TIPS. Also, the businesses that the wealthy own and the jobs they typically have are generally better inflation hedges than the less secure and less lucrative jobs Joe Average holds.

6. Lower Advisory Fees

Average Joe generally can’t afford good advice, which often isn’t available until a portfolio reaches a size of $500,000 or more. He is left to his own devices or perhaps the “advice” of a commissioned mutual fund salesman or insurance agent.

A wealthy high-earner, however, often engages a fee-only advisor who charges a fee, often 1% or more, of the assets under management. Every dollar invested increases those fees. But a dollar that is paid toward a mortgage does not. That has the effect of increasing the “return” on the money used to pay off your mortgage by 1%.

Two Reasons That Don’t Matter So Much

Some advisors recommend that the wealthy pay off their mortgage because of the Pease phase-outs. These phase-outs purportedly reduce the value for high earners of all of the below-the-line, itemized deductions like state income taxes, charitable contributions, and mortgage interest. However, the actual effect of this provision of the tax code is to increase the marginal tax rate by about 1%. It doesn’t actually decrease the value of those deductions at all. [Update July 2018: Pease phase-outs are gone with the new Tax Cuts and Jobs Act. – Ed]

Another great reason to pay off debt, whether student loans or a mortgage, is that it increases your financial freedom and allows you to take risks and take advantage of opportunities you would not otherwise be able to do. However, this aspect really isn’t any different for high earners than for low earners.

In conclusion, whether you pay off a mortgage or invest is always an individual decision and many factors should be considered. However, all else being equal, a wealthy high-earner should be much more interested in paying off his mortgage than someone with a five-figure household income.

What do you think? Did you pay off your mortgage early? Do you plan to? Why or why not? Comment below!


9 COMMENTS

  1. I paid off my mortgage early because it just didn’t make any sense to me to have the same amount sitting in a bond fund that was paying me 2-3%. Paying it off got me the same return guaranteed and is considered by many to be a bond equivalent.

    It was one of the best moves I ever made. Once you pay off the mortgage, it’s just magic how much extra money you have to invest above and beyond your previous savings rate.

  2. We have enough money to pay off our mortgage, but with only 9 years left at 3%, it absolutely makes no sense for us. We will still itemize under the new tax law so that 3% mortgage is an effective 2%.

    We make way more than that in our taxable account.

  3. I have been completely debt-free for about 15 years. It was more of an emotional decision than a financial one. My stress level dropped. I didn’t even know I had that debt-induced stress until it was gone. I have no regrets about paying off all the debt. If I ever change my mind and want a mortgage, I can get one at any point. I don’t see that happening though!

  4. I refinanced my (some of my) home for 20 years five or six years ago when interest rates were 2.75%, the lowest rates in the last 50+ years. After tax, this is about 1.75% cost. If my after tax return on investment is greater than 1.75% over 20 years, it is a winning strategy. So far it’s working.
    This is not for everyone, particularly as rates go up and if stock market returns drop.

    • That’s a great rate, even without the mortgage interest deduction. With the recent tax law changes, will you still be itemizing deductions? I’ll be taking the standard deduction for the first time in my anesthesia career, and I think a lot of docs will find themselves in the same boat. The math is a bit different now with increasing mortgage rates and the loss of the deduction for some.

      Cheers!
      -PoF

  5. There is a great peace when you know that your home is not at risk if something happens financially to you. With no debt, your house will never be taken by its “rightful” owner, the bank. Gambling with your home, even if you call it investing, is not wise. I paid off my mortgage 17 years ago and all of those payments I no longer needed to make have been invested. That’s a lot of safe investing. You don’t see people who pay off their homes, later deciding that it would be better if they borrowed against the home to make some investments at a higher potential return. People who have paid off their house and have lived both with and without a mortgage, rarely go back to having a mortgage. Take this advice from people who have done it both ways, not just worked it out on paper. Pay off the house.

    Dr. Cory S. Fawcett
    Prescription for Financial Success

  6. I did max my 401K, two Roth’s and saved another 15% in taxable accounts and still paid the house off early. That wasn’t hard at all because I limited myself to a house that cost only about one year’s income when we bought it and my income went up a lot after that. In fact the average car now costs more than the house did when we bought it and we are still in that same house. We added on, doubled it in size in eight different cash funded projects over the years and it is a nice house with modern internals. But still it was worth less than a year’s pay when I retired. Ideally your house should represent a negligible piece of your net worth that you could give away and not impact your finances significantly. There is too much risk that your neighborhood might decline to have major assets tied up in a house. I think if people use restraint and don’t get a house that costs more than a year’s income then they should be able to max out retirement accounts and still pay the house off early. They also should be paying for their cars with cash as well, even the first ones.

  7. Debt free is definitely the way to go for me. Non monetary rewards for me are worth the potential money lost by not investing. Peace of mind is something you never know how valuable it is until you have it.

    I have commented on this before on POF but ask yourself this, if you had a fully paid off home would you take a mortgage out to invest that money? The fact that you wouldn’t speaks to how valuable that non monetary benefit is.

    And once that mortgage is paid off all that money can then be funneled to investing, which is what I have done since I paid off the mortgage.

    • I don’t know. If I could get a 15 year loan at 3% against my house and let it ride on VTSAX, a few crowdfunding deal, or private REIT paying 8%, I’d do it. For now, I’m keeping my mortgage. I have 9 years left at 3% (effective 2% after mortgage deduction). I am still going to itemize.

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