Still more debt advocacy

Once again I encounter another article describing why a person should not seek to pay off their mortgage quickly. This time it’s Deborah Kearns of NerdWallet writing on USA Today in an article called “4 reasons why paying off your mortgage isn’t always the best move“. And sadly, she doesn’t give any original reasons. It’s all stuff I’ve heard before.

And much of it boils down to the assumption that those who put extra money toward their mortgage are not otherwise financially prepared. Paying your mortgage down early is a major financial investment, not something to take lightly. You shouldn’t do it unless you’re prepared for it.

And preparing for it means doing the math on it. You need to determine how much extra you can afford to put toward it without sacrificing an emergency fund and other things. Indeed, as much as I deride him, Dave Ramsey has it right when he says that building up an emergency fund — he advocates 1000 USD instead of the typical “three to six months expenses” simply because it’s an easier goal to meet — must come before paying off your debts, including your mortgage if you’re so inclined.

So with many of the articles riling against the idea of paying down your mortgage early, they all basically say, in short, to not pay down your mortgage early because you need an emergency fund and you need to plan for the future. Not “don’t put extra money at your mortgage until you have an emergency fund and a financial outlook plan”. In other words: don’t put extra money at your mortgage at all.

The only thing in the article that is actually new, from what I’ve typically seen, is mentioning the mortgage interest tax deduction. And that has to be the stupidest reason to not put extra money at your mortgage. In an article I wrote back in 2010, I said this about the tax deduction:

First, you can only deduct the interest paid on your mortgage if you itemize. If you don’t itemize, you can’t declare the deduction. This is in contrast with student loan interest deductions which don’t require you to itemize. This means that the benefit of the deduction must be taken in contrast with the standard deduction for your filing status. If your mortgage interest deduction along with other itemized deductions is less than the standard deduction, you’d be stupid to itemize.

This means for married couples filing joint, if the mortgage interest deduction is less than about $11,000, and you don’t have other itemized deductions you can take to bring the itemized to more than the standard deduction, why itemize? This means that for a married couple filing joint, you’d need a mortgage of at least about $200 thousand. For married filing separately or single, you’ll need a mortgage of at least about $100 thousand to make the tax benefits worthwhile.

That’s a lot of interest to be writing off. But again it’s a deduction you can take only if you itemize. I believe about the time I wrote that article, my parents had determined that they didn’t pay enough interest on their mortgage to justify taking that deduction. The standard deduction was the better choice.

Which means you could stick with your minimum mortgage payment until the deduction is no longer worthwhile, and then accelerate payments after that point.

Paying down your mortgage faster ahead of that point means you lose that benefit — to the extent it can be called that — faster. But the tax savings that are lost (remember it’s a deduction, meaning it reduces your tax liability only by reducing your taxable income) are likely offset by the interest savings over time:

That said, the amount you’ll save with the mortgage interest deduction probably won’t outweigh what you’d save on interest. The real benefit comes in the initial years of borrowing; but over time, you’ll pay less to interest and more to principal.

Loans are front-loaded on interest, meaning you pay the most interest up front merely because of how the interest is calculated. This means it takes years to build equity in the home. Again referencing the above-linked article from 2010:

But going on the mortgage, here are some surprising numbers for you, going on a 30-year mortgage with a 5% interest rate:

  • After 1 year, you will have not even paid off 1.5% of the balance
  • It will take 10 years to pay off only 20% of the balance.
  • It will take 20 years to pay off 50% of the balance.

My, what big equity you’re building there — 20 years until you have 50% equity in the home. And this isn’t counting any other liabilities you might have against the home or any improvements you’ve made to it, only the initial mortgage. You might be building equity, albeit very slowly, but what you’re left with at the end, adjusted for inflation, is likely not much more valuable compared to where you started.

So paying down your mortgage faster builds equity sooner. And if you didn’t put down the 20% down payment on your mortgage, and therefore also have to pay for mortgage insurance as part of your payment, then accelerating payments to at least get down under that 20% threshold should be an initial goal since that will lower your mortgage payment from then onward.

But the beauty of how the math works also means you’ll see a benefit by putting extra money toward your mortgage. You don’t have to go out of your way either. I’ve said in a previous article to merely round your mortgage payment up to the next $50 or $100 increment. For example if you have a payment of $635/month, take it up to $650 or even $700. You’ll build equity faster since you’ll be paying less interest over time, meaning more of each future payment goes to principal. While adding merely $15/month to your payment won’t see a significant benefit over time, adding 10% to your mortgage payment will.

And it works with other loans just as easily. If you have a student loan, you should be accelerating payments toward that as well.

And even if you put more money toward your mortgage, you can always back off if need be in times of emergency. Depending on how your bank calculates your mortgage payment, you might even be able to completely skip a month but still come out ahead. And if you need a deferment, being ahead on your loan means your bank will be more likely to approve it, thereby alleviating a liability in a case of emergency.