Is Paying Off Your Mortgage Early a HUGE Mistake?

it's brian preston the money guy mortgage free at all expense because realize people get so excited about becoming debt free and this is one i even want to give cover for somebody that lives in our backyard yes that a lot of people will get excited because dave ramsey has them and everybody at ramsey solutions has them excited about getting out of debt but then they screw it up they're not even doing the babysitter that's right they are doing davish yep whereas they get so excited about getting out of credit card debt they get so excited about the high interest student loan debt because remember you do need to make an analysis is this low interest or is this high interest student loan debt and then they move on right to the low interest mortgage that's right and mortgage i think is a really interesting one because we just showed that you know where caitlin and thomas the previous example ended up okay sheila ended up in a less than optimal situation but she still had some savings built up the mortgage is a little bit different mortgage is one that can leave you in a more dire circumstance and you don't even realize it well i think mortgages because we're now talking about interest rates that are less than three percent holy cow i mean can you fast forward and think about what this looks like in years in the future as interest rates go up but i do want to bring it back to a case study okay um i you know i i i have a sunday school class and i had one when i first started doing this sunday school class with another couple um we had i had a a woman come up to me she was brand new to the class and she says i'm a widow and i wanted i know as soon as i found out what you did for a living i want you i want to tell you something so nobody else makes the mistake that i made okay and here's what her story was is that her husband passed away um you know kind of younger this was sub 50 so this was kind of unexpected and she got some life insurance money and a lot of the people in you know around her said you know what you need to do you need to just pay off the mortgage just go ahead and get rid of that debt because that way if no matter what comes your way you'll have a paid for house you have shelter over your head and she says she did that she took that life insurance money and this is somebody by the way in their 40s so i don't even you know i'm prepaying debt it's not i'm not going to fight you on that if it's the right time in your financial order of operations but here's the rest of the story on this is she goes i used all that life insurance money paid off the debt and then i still got kids in the house when it came time to buy them supplies for school when it came time to pay insurance premiums when it came time to pay property taxes i didn't have any liquidity to pay the bills so i you know because and this is something we say all the time though you can't eat a house can't eat a house so i mean you can have all the equity in the world in your house but if you need cash if you need money you're going to be in trouble now there's nothing wrong i think i always like a more balanced approach and this is what i love about what we've created with financial world operations is that if she would have probably be done a balance meaning made sure she had the cash reserves settled up made sure she had enough money set forward for the future there probably was a chunk of money that could have gone towards the mortgage absolutely to pay it down substantially faster but it didn't need to be an all or nothing type strategy which a lot of people when they're so excited about getting out of debt that they screw that whole process up and what i think is really interesting is this does not just happen with windfalls this isn't this we don't just see this when someone comes into life insurance or an inheritance or something like that we see this a lot with folks who are planning for financial independence and they're under the impression that this is the prudent way to get to financial independence what they don't realize is that wealth building is a young person's game it is i mean it really is i mean think about when you're 20 years old you can swing for the fences on risk you can do an s p type 5 500 equivalent type investment which historically around 10 percent every year if you can make it through the the ups and downs remember you're walking up that mountain with the yoyo yes there is ups and downs in the short term but long term it's good and also young man's game young woman's game and the fact that while you're in your 20s you actually should be very excited every time the market is getting its teeth kicked in get excited because you got a lot more that you're buying versus you're not using much at that point you're building your army of dollar bills but people get so thrown off on this is that they don't understand when you're 20 years old every dollar has the power to become 88 exactly right when you're 30 every dollar has the power to become 23 dollars because realize as you get older you're going to have to start dialing down the risk you'll start adding more asset allocation by the time you're 40 years old every dollar by the time you turn 65 has the potential to turn into seven dollars do you hear those drop-offs from 88 23. now we're at seven guys this is a young person's game make sure you're not squandering that opportunity because remember what are the three components of wealth creation it's discipline it's money from the margin that you've created and then give it the respect of the time to let it grow yeah and brian you said earlier something i think is so interesting i hear this from a lot of folks in the fire movement especially those folks who are in their 30s and 40s and or who want to be financially independent in their 30s and 40s and say no i'm going to get my debt paid off and then i'm going to have all that extra money that i can throw in the portfolio so once i get that gone well i would encourage you if you're someone who has that mindset i want you to go to our website go to moneyguy.com resources and i want you to look at our wealth multiplier now the actual name of this thing is called how powerful are your dollars because somebody told us it's not called wealth multiplier that's just what we dubbed it what this shows is exactly how powerful every dollar can be at each age so if you're a 33 year old thinking man should i really pre-pay my mortgage or should i take that money to have it work for me every dollar that you deploy at age 33 will turn over 16 times by the time you hit 65. if you don't understand this concept go download this deliverable it's completely free take this and use this to inform yourself in how you make financial decisions so you hit it you just said what we think is the extreme which is a lot of people will say especially as you mentioned we kind of the fire movement financial independence retire early they think that if they can get out of debt they will then throw all of the throw everything but the kitchen sink on top of saving for the future we're not even when we do this case study bow we're not even going to take that extreme of a approach what i wanted to do was i said let's go with this in a different route what if you're because remember this is the other part we talk about the messy middle of your 30s you got typically you're new to marriage new to owning houses new to having children and so life is just kicking you all over the place so you margin especially remember that component of wealth creation which is discipline and then money you've got to have the money so you can have army of dollar bills that's harder to do especially when you're told you've got to go buy a 15-yard mortgage especially if you're in a rising uh appreciating real estate market if you live on either either the coast or in a hot city like austin texas or nashville tennessee i mean i feel so bad i've had so many discussions with even our own employees and i'm like look the reality is you might not have 20 on the first house i'm giving you a pass on that first house so make sure you understand that you just gotta get on the train so you can have the shelter so you can have the money and and have it working for you by getting the benefits of home ownership and then people just take it the extreme and they say well i've been told i need to do a 15 year mortgage well yeah i love that because i know the stat that the typical millionaire according to some of the researchers they pay their house off in 10 years we know that stat that's not their first house not the first home it's typically the third home and by the way i resemble this status that you do once you cross 45 and as we told you that wealth multiplier impact is much smaller there is nothing wrong with attacking the debt but what i'm worried about is that 20 something or that 30-something that chooses a 15-year mortgage versus a traditional 30-year mortgage not realizing they might need that margin so they can still have money for for paying all the bills taking care of the kiddos as well as making sure your army of dollar bills is not disrespected i'll take it a step further and say i just think it's really solid and sound mathematics given where interest rates are right now because again conventional wisdom used to be yeah do the 15 year do that well now that conventional wisdom might not hold so true so again in true money guy fashion we wanted to do a case study we wanted to kind of put the numbers to the test to see if it actually pans out so fte daniel again hooking us up with an illustration let's take two individuals dave and melissa and let's assume that they're both 25 years old and they both are going to buy a home and let's say that the purchase price of that home is 300 000 they're going to put 20 down so they're both going to take out a mortgage of 240 000 so two 25 year olds they're going to buy each buy a house 240 000 mortgage uh dave says you know what i'm going to go with conventional wisdom i'm going to do a 15-year mortgage melissa says you know i've been listening to the money guy show i think i'm going to go with a 30-year well because dave did the 15 year he gets a more attractive mortgage rate his interest rate on his mortgage is only two and a half percent melissa has to take a slightly higher rate because she's doing a 30-year so her rate's going to be 3.25 so dave already is looking much better here dave's monthly payment just like you said because it's a 15-year mortgage is higher he's got to pay 1600 a month on his mortgage because melissa is stretching hers out over 30 years her monthly mortgage payment is only a little over a thousand dollars at a thousand and forty four dollars so wait a minute wait a minute i wanna there's several things here first of all 15-year mortgage two and a half percent i get excited that sounds exciting but i'm also in my late 40s so i should get excited over a 15-year versus a 30-year here's another key thing the same house there was no difference in purchase price these houses we have a 300 000 house we're also only financing 80 doing all the conventional things that you're told the difference in the monthly payment is sixteen hundred dollars on the 15 year versus a thirty years a thousand forty four that leaves an additional 500 plus dollars of extra margin that's right so what are we gonna do with that five hundred dollars so here's what we're gonna so we're gonna assume melissa recognizes there's an opportunity here so she's gonna invest that extra 556 dollars well then once her mortgage is paid off after 30 years she's going to invest the full amount the 600 dave because his mortgage will be gone after 15 years he's actually gonna start investing sixteen hundred dollars after fifteen years so again and you said this earlier brian this is the exact same cash outflow they are both for the next 30 years gonna have sixteen hundred dollars a month flowing out days is going to go all to the mortgage melissa's is gonna have a thousand go to the mortgage but an extra 556 dollars is going to go to an investment account so we've done this before we did this called this tell of two savers exactly where it's title now but guys this is the new and improved we took all of your negative comments and we said let's go let's go troll slam you know so we're knocking them down with the hammer you go wait until you see what we've done with this so let's look at how both of them look so if you're again if you're listening out on uh itunes i heart radio stitcher any of those places spotify you ought to go check out the youtube because this illustration is really really powerful because here's what i think is interesting at age 30 so after the first five years dave's mortgage is down to a little over a hundred and sixty nine thousand melissa still all still owes 214 thousand dollars so dave has been knocking down the mortgage hardcore but melissa does have about forty three thousand dollars invested so she has a little bit of money saved up by age forty and this is what i think is really remarkable dave is completely debt free yeah he has no mortgage he owns his house he gets to sit on the earth that he has but he also has no investments so i got to think at age at age 40. dave's feelings feeling great he's sweet even though he you know he's not looking over at melissa's page yet to see what she's doing because he's feeling really good about being debt-free meanwhile melissa still has a mortgage she still has a 148 000 mortgage when dave just paid us off so if they're at the cocktail party dave is bragging and melissa's like oh man did i make the right decision however she does have 212 thousand dollars saved up so technically if you look at the total net net she's 64 000 ahead of dave at age 40 right so 15 years in well if we go to 50 now remember dave started saving more money as soon as his as soon as his mortgage paid off so he has 1600 a month going into the investment account at that time melissa only still has 556 going in so he's saving three times as much on a monthly basis well at age 50 he still has zero mortgage he's actually built up now almost three hundred thousand dollars 296 000. melissa still has the mortgage that thing's still hanging around she owes 58 000 but her investment account is worth 573 000 so now at age 50 after 25 years she is almost two hundred and twenty thousand dollars ahead of dave now before we we kind of go to the grad you know go to to 60 the graduation point here to see what things look like if you're making decisions on retirement i noticed there's some fine print at the bottom of this yes that we didn't get so crafty that we assumed hey you're going to put this in an s p 500 index fund during the entire short 30 to 40 year period we're actually i see a little slope there a glide path you know in your 20s is ten percent thirties it's nine percent in your forties it's dropping down to eight percent seven and by the time you're in your fifties it's seven percent and you see we keep dropping it down into six percent even in your sixties that is the way it works in real life too is you dial the risk down that's all accounted for all the interest expense are accounted for this is an apples to apple so what's the big impact and this is how we're able to do a show title like your decision can cost you millions that's right by age 60 they are both debt free so they both now own their home dave has an investment portfolio worth 871 thousand dollars which is excellent 871 000 nothing to be scoffed at however melissa's portfolio she's also debt free but she now has over 1.2 million dollars almost 1.25 million dollars it is a 375 000 difference and i just think it's worth reminding you they both had the exact same amount of money flowing out every month from the time they were 25 all the way until they were 60. so this difference could be also like roth savings is here but remember these are typically the same person that's making this mistake is also missing out on that employer match for that period i'm telling you if you start stacking these differences you quickly can see that this is not a six figure mistake this could quickly turn into a seven figure mistake without a zero difference in how the dollars were spent it's all on the decision making it's all about the financial order of operations and getting things out of whack and not maximizing every dollar that comes into your per your custody and making sure you are using maximization techniques now i do think i'm going to throw a disclaimer out real quick because a lot of folks in the chat one of the beautiful things about the live chat is we can see what you're saying here saying yeah i did a mix i'm still investing but i'm paying all we're trying to lay out for is the mathematics the beautiful thing about financial planning is it's part math and science but there's also part art to it you have to think about what are your ultimate goals what are the things you're what's your wants what's your why we're not saying that one of these is 100 right and the other is 100 wrong we're just showing you the numbers so that you can make an informed decision to take your finances to the next level and look i i will tell you i am post 45 so i have been working on accelerating my debt payment because i'm way past saving 25 of my income it makes complete sense to be responsible and get that debt paid off because i can i mean it is one of those things but you and i had several discussions in march when the stock market got crushed you're like you're crazy if you're still accelerating your debt prepayment right now and i took it to heart i was like you know what he's always right i mean because my interest rate is super low on this mortgage i ought to probably take these next few months while the market has this type of volatility has this type of valuation ought to load up everything that was going towards that low interest mortgage ought to go into the the equity markets and sure enough it did now i mean it is one of those things that i think that you have to take into account your why you have to take into account what you're saving because remember i have no problem here's the thing i think is interesting about financial order of operations the trick question that would be out there in trivial pursuit if you were doing foo edition of this is can you be 35 years old or even 30 years old and pre-pay your mortgage and brian and bo not get mad at you yeah the answer is yes because you've gone through all the other steps of the financial order of operation is that you saving 25 of your income you're saving to make sure that all your prepaid expenses of thinking about the kiddos college other things and all those things have been respected and you still have money because maybe you're in a high income situation yeah go knock it out go go destroy the debt i'm perfectly fine with that because you've paid respect to the financial order of operations and done it in the right order yep i love it love it love it

Channel: The Money Guy Show

Views: 84,522

Rating: 4.6342859 out of 5

Keywords: money guy show, debt, budget, cash, real estate, insurance, how to make money, save, credit card, compound interest, buying house, buy stock, success, personal finance, Is Paying Off Your Mortgage Early a HUGE Mistake?

Id: 36BN42mat10

Length: 18min 25sec (1105 seconds)

Published: Thu Sep 17 2020