The feeling of having a fully paid off house is incredible. But at what cost should you do it as fast as possible? I like to highlight the disadvantages of paying off your mortgage fast. This is a topic that is highly discussed in the financial independent retire early movement. ‘You should pay of your mortgage and only then start investing, mortgage is a debt and therefore it is bad’. Or the opposite: ‘Don’t pay off your mortgage fast, invest the money in stocks’. Which is right?

Well, it depends…

What answer is right depends on your own situation. For example your interest rate. If you pay off your mortgage and your house is paid for in full, you have a lot more money to put in your index funds and other investments, making you more profit by compounding interest after you’ve paid off the house. On the other hand, if your interest rate is low, you can consider just paying of the minimum required and invest the surplus in a low fee index fund or however your investment portfolio suggests. Chances are you can easily make a higher profit on that.

Look at it this way: the interest rate on your mortgage is your guaranteed return of investment if you pay it off. If you have an 8% or more interest rate, you are probably better off paying it off as soon as possible, for the chance of making more on the stock market is a gamble. If your interest rate is low, say 2%, your return of investment is probably higher on the stock market then when you down pay it on the mortgage. I heard of people in the Netherlands that bought a house with just over or even under (!) 1% interest rate these days. It is not that hard to outperform that with investing. Index funds like the S&P500 perform at an average of 8% per year. Please don’t look at this in the terms of one or two years. Look at this more in the 15-30 year range. If you put your money in an index fund, in the long run you will earn about 8% on it. Yes, even if you are at loss right now or the first few years.

Inflation

Other disadvantages of paying off your mortgage for example are inflation. So if you pay of your house now, you are putting a higher percentage of your income to it. In the future, with inflation, your income will increase and the same amount of mortgage left will be worth less than it is today. So in that sense, it would be better to pay if off as slow as possible. But of course it all depends on the percentage of interest you pay.  

More than 6%.

What to do if your mortgage interest rate is higher than 6%? What will happen if you pay it off faster? On the ROI (Return of investment) side, you will get more return on your money (by not handing it over to the bank as interest).Think hard on doing a down payment, once it’s in the mortgage you can’t spend or invest it anymore. This is called the opportunity cost. It’s basically gone until you sell your house, but probably it will be in another house you buy next.

My best bet is check if you can refinance to a lower interest rate. This may cost you a fee right now but calculate it and see if it will be cheaper in the long run.

Between 3-6%.

What if your interest rate is between 3-6%? Try and refinance it as well, call your bank, check how to refinance, shop around at other providers as well. Calculate what you save vs. what the fine of refinancing is. Make your own decision. Same as for the high interest rate, maybe it will be good to do down payments but you will not be able to touch that money for anything else anymore. The opportunity cost is at stake here too.

Under 3%.

If your interest rate is low, let say under 3%, I would not pay it off any faster than required. Put money you are not spending in a low-fee index fund every month and grow your stash that way. The chances of having a higher return of investment are on your side. Especially in the long run. The big benefit here is the money is more liquid, easier to access in case of emergency.

In the netherlands

The taxsystem in the Netherlands makes the disadvantages of paying off your mortgage even bigger. Here in the Netherlands chances are you are getting hypotheek rente aftrek (tax deductionon the interest). This makes the net interest rate even lower. And there is the possibility your paid off house will cost you more in taxes in the future. If your house is currently worth more than the remains of the mortgage, call your bank to ask for a lower interest rate (schuld-marktwaarde verhouding). This only works when you don’t have NHG on it. Chances are the interest rate will be lowered.

But if anything, don’t store surplus money on your savings, as it is zero or close to zero at the moment.

And remember:

I am not a Financial advisor nor am I your financial advisor. I am not a trained financial professional. This blog is for entertainment purposes only.

What’s your thought on this subject?

Untill next time,

Elske