Why You Should Stop Paying Down Your Mortgage

hi I'm Sharon windsmith a tax attorney active investor in your go-to resource for proven investment and tax planning strategies before you start the video please go ahead and like the video because that helps me really grow my channel and get my content out there in this video I'm going to talk to you about why if you have excess cash on hand you should hesitate before paying down your mortgage I'm going to explain to you how to think about the opportunity costs when it comes to paying off debt as opposed to investing excess money I want to caution at the beginning that this video is really only for sophisticated investors who are very disciplined if you are someone who has a lot of bad debt like credit card debt student loans things like that or you're someone who really can't control your spending habits then this is not the video for you and you could get yourself in a lot of trouble so I'm going to explain a situation where if you have a fact pattern where your mortgage on your home is at a very low interest rate like three four five percent even in some cases but you were able to invest money in a way that you can get returns in excess of that interest rate on your mortgage how you want to consider maybe not paying off more than you need to each month and instead investing that excess cash so the reason I think this video is very important is that a lot of people out there more outdated thinkers like Dave Ramsey would tell you make double triple mortgage payments if you can each month pay off that mortgage as soon as possible I know with our grandparents generation that one of the best days of their lives was when they paid off their mortgage and they owned their house outright that actually in my opinion is very poor planning I don't really know why anyone will want to pay off their mortgage if you can have the ability to borrow against your home and invest in a way that you are making better returns than you would have by paying off that debt then it makes no sense to really pay that down again this is assuming that you're a disciplined investor and really understand how opportunity cost works when it comes to investing so the point again I'm trying to illustrate is that when you are Building Wealth you need to think about opportunity costs and how you can put your money to the best use possible how can you maximize the returns that you get on that money and invest it and use it in a way that you're going to increase your wealth in the most efficient way possible without taking on too much bad risk before I start I'm going to walk you through an example of how this would work in practice but this strategy only works if the interest on your mortgage is lower than the investment returns so if you're someone that for some reason has a really high interest rate like seven eight percent this strategy is not going to work for you until you can do a refinance and get a lower interest rate you need to have a situation where you can invest your money in a way that you're very comfortable on average those returns are going to exceed the interest rate that you have to pay on your mortgage and when I walk you through the example you'll understand why that's the case a little bit more the other thing I want to mention is that there are other reasons why it might be beneficial not to pay down a mortgage for example having a mortgage or having debt on anything provides asset protection because that makes you an unattractive litigant and it means anyone suing you trying to come after your money or your home they have to get in line behind the bank which no one wants to be in line behind the bank because the bank or the lender on that asset which in this case is your home is always going to become first and first in line so let's Dive Right into an example of how this would work in practice so in this fact pattern I've assumed that we've bought a home worth a million dollars I think that's a pretty reasonable amount for our personal residence if you live in New York City like I do and you buy a home then you're probably going to pay a lot more than that but in other parts of the country you can probably you know get a decent sized home for that amount so just to make it simple value at the home is a million we took out a mortgage of eight hundred thousand and put 20 down of 200 000. so I always like to put the least amount down as possible when I can get a low interest rate you always should be able to get a low interest rate on mortgages if right now when I'm recording this video interest rates are quite high so it would not be the time to buy a home and or refinance your house you would want to wait until interest rates are lower but most people have a good interest rate you know on their mortgage three four percent range is a really good rate to lock in there for a mortgage I know you know a year or so ago you could actually sometimes even get rates better than that so I'm going to assume an interest rate of 3.5 percent on the mortgage and I think that that's a pretty you know reasonable amount and pretty average based on you know what what a lot of people have I'm going to assume a 30-year term because I like you know longest term as possible and again I'm not talking about that you don't have to make those monthly mortgage um principal and interest payments you do have to pay those if you don't pay those you're going to kill your credit score and have a really bad situation so you've got to pay the those monthly payments that are required in this case you're going to pay principal of twenty six thousand six hundred and sixty seven dollars and you're going to pay interest of twenty eight thousand so that's every year you've got to pay that over to the bank that's a total of fifty four thousand six hundred and sixty six dollars that is your annual mortgage payment when this is your fact pattern and these are the terms of your mortgage so for my example I'm going to assume that I could get investment return of eight percent on average this is a pretty I think very reasonable Return To Expect if you were just investing something like an S P 500 Index Fund this would be a pretty good return average that you could expect from that investment I know you know if you're getting lower than that you might want to think about you know your investment strategy and if you're doing everything right there because I in my opinion eight percent should be pretty easy to get on average every year I get a lot higher than that again without taking on unnecessarily crazy risk so this is the investment return that you could get this is your interest rate these two are going to become important because I'm going to show you why investing money and getting investment returns of eight percent every year is better than paying down a mortgage or debt where you have 3.5 interest on that debt to finalize this fact pattern I want to assume that you have excess money every year of fifty thousand dollars so after you pay all your expenses pay everything else and and make your mortgage payment to the bank you've got an extra fifty thousand dollars cash on hand so you can either listen to Dave Ramsey and use that fifty thousand dollars to pay down your your principal and your mortgage and get rid of that sooner or you can listen to me and do option two that I'll walk you through where you invest that fifty thousand dollars and just keep making the mortgage payments that you're required to make but nothing above that so I'm going to walk you through two those two options that I just discussed and I'm going to show you why you're better off doing the ladder assuming that you don't invest in something dumb that's gonna you know make you lose your money yes there is risk here with everything comes to risk so some people would say that you know if you pay off your mortgage that's risk-free because you're paying off debt with cash however I disagree with that that view of risk I think that's a very you know untraditional view excuse me a very traditional view of risk and a little bit outdated I think paying off debt where you have 3.5 interest is one of the more risky things that you can do if you're a very Savvy and sophisticated investor so again this only works if you can get you know eight percent or higher than 3.5 percent Returns on your investment this money that you're going to invest every year on average if you can exceed that so we're looking at the opportunity cost we're looking at the Arbitrage between those two numbers those two interest rates and how we can maximize our wealth by using that money that extra fifty thousand we have each year by putting it to its best use so let's just run through really quickly how this would look in practice so let's say option one you listen to Dave Ramsey and you pay down that mortgage so I've hidden some of the cells so that just as easier to look at but you're going year 0 through 10 here you know I've got my outstanding mortgage of 800 000 starting you know January 1st of 2023 when I took out the mortgage I have to pay this principal every year I've got to pay this no matter what you know you're required to pay off that principal amount every year and I've got you know an extra fifty thousand that I mentioned so I'm going to listen Dave Ramsey I'm gonna pay down my mortgage balance so my mortgage balance at the end of year one is 723 000. when I keep repeating this out year two it's 646 000 all the way to year 10 when I have paid off my mortgage so pop the champagne the bank's gonna send you balloons and say congratulations you own this house outright what is my net worth situation look at at that point so I own my home clear turn out right the equity in my home is a million dollars so I'm gonna say that I have a you know a million dollar asset there I think it's debatable whether or not your home is an asset I personally think it's not but for purposes of this example I'm going to show you've got a million dollars of equity in your home that you know because you paid off your full mortgage you own it outright other assets I got a little bit of other assets I got cash of 43 000 because I didn't need the full 50 to pay it off in year 10. I only needed six you know six thousand dollars to pay off the rest of that mortgage so I've got an extra forty three thousand dollars that now I can do whatever I want with that because I I don't have to make any more mortgage payments to the bank so my total net worth in year 10 once I paid off my mortgage is one million forty three thousand dollars so that might sound great like yeah you know I own my home I'm a millionaire um this is a terrible balance sheet by the way if this is your balance sheet but let's say you know you're a millionaire you paid off your home and that's the result at the end of year one so you might think that's great but I'm gonna show you why you would have been better off if you hadn't paid down that mortgage and use that fifty thousand dollars to pay off the principal but instead invested that money in a way that you get eight percent returns so let's look at option two which is the way I would do this because I'm comfortable that I can invest my money in a way I'm not taking on a lot of risk if really you know any material risk at all and get eight percent return so this is a great strategy for someone like myself who's a very disciplined investor and understands how this works and understands the risk I'm taking on by doing this strategy so what's different from option one here is that might begin I'm looking here instead of my my principal paid out on my mortgage I'm looking at my investment so this is Investments outside of your home your home is not an investment it 100 is not ever an investment so your beginning investment here is zero and your annual gain is zero because you didn't have any Investments to earn any Returns on but when I come December 31st at the end of the year I've got an extra fifty thousand dollars that I can invest so my investment value at the end of year one is fifty thousand dollars so when I start the next year 2024 I've got fifty thousand dollars that I'm investing from day one I get eight percent return on that so I've made four thousand dollars in that year and again I've got another fifty thousand dollars that you're in that I can put into that investment if it's an index fund you know for example I'm putting another fifty thousand dollars in there and so now at the end of year 2024 I've got a hundred and four thousand dollars of Investments on hand remember if I were in option one I don't have any Investments my investments are still zero because I was paying off that mortgage payment principle I was not investing that money so again this plays all the way out we're going to go all the way out to year 10 here because of the beauty of compounding my beginning value of my investment whatever that investment is I'm going to assume it's like an S P 500 Index Fund my value is seven hundred and twenty four thousand dollars three hundred and twenty eight dollars so that is you know a great a great situation to have you know you can really see why compounding can really really is magical it really is a great thing and again my annual gain now I'm making almost sixty thousand dollars a year on my investment and again I can put another 50 000 in because I didn't make any excess mortgage principal pay Downs so when all is said and done at the end of year 10 in 2033 I've got an investment worth 832 274 dollars that is an investment that I have doing this strategy in option two that I did not have an option one so you may say yeah but you had you know you owned your home clearing outright in option one yes that is true but I also have a ton of equity in my home in year 10 because I've had to pay down that mortgage the bank requires me to pay down that same amount so I'm still doing this I'm still paying that twenty six thousand dollars every year so at the end of the day and the end of year 10 I have 493 333 dollars of equity in my home so that is compared with you know the million that I had here so you might say well I hadn't you know double the equity in my home so I'm better off but that's not true you have other assets of eight hundred and thirty two thousand dollars so your total net worth is over 1.3 million dollars so that me means that by doing option two and investing that excess money in a way that you earned returns that exceeded it far exceeded in this case the interest that you're paying on the debt you have a difference in net worth of almost three hundred thousand dollars so this is a way that you can really see how putting money to its most efficient use can really help you compound and build net worth in a much more efficient way now you may say that well now I don't have to pay any mortgage payments every year you know I've got that extra fifty five thousand dollars that I can invest and make eight percent returns now whereas you know in the fact pattern of option two you're still making that investment you're still having to excuse me you're still having to pay the bank that amount where is an option one that you're not but you've got this asset worth eight hundred and thirty two thousand dollars that is earning inch earning returns every year of eight percent as opposed to now you've got you know to start that compounding from day one you're starting to build that asset that you're investing from essentially zero and option one because you weren't investing anything you were just paying off the debt and very low interest rate debt so again if you play this out to all the way to the end of the term of the mortgage you are you see that the the difference the Gap and the difference in net worth gets even bigger you you know would would be much higher you would be much better off in option two and I will say this is commonly a strategy where you take out do cash out Equity refinancing where you know every now and then when interest rates are low again or if they're lower than where your mortgage is today then a lot of people like to do refinances and pull that Equity out of your home equity stripping is a great asset protection until it's also a great wealth building tool because what I'm going to do personally I don't own my home but if I did I'm not ever paying off too much of that mortgage I'm going to keep refinancing whenever interest rates are low and I don't have to pay a bunch of money to the bank you know and closing costs to do that I don't you know there's no Rhyme or Reason to how often people do it some people do it every five or ten years it's a very common tool used by Real Estate Investors to do Equity stripping or you know cash out refi's where you just keep pulling that Equity out of the home and so when you do that strategy again this difference and the amount of net worth you're going to be able to accumulate in option two is going to just get bigger and bigger and bigger so again you know be careful with this strategy again it's thinking about opportunity cost as an investor if you can really conceptualize this and understand why this works the way it does and why these examples shake out the way they do then you are going to be a very sophisticated investor you're going to be ahead of the game because investing means understanding how to think about making money how to invest efficiently how not to take on too much risk again you know it sounds great to get eight percent returns but you've got to be investing in something that you feel pretty good about is going to give you eight percent on average you could of course get yourself into a lot of trouble if you lose all your money and you know lose everything then then that's obviously not not a great result but you should be able to if you're a sophisticated investor you should be able to invest your money in a way that you can comfortably and safely get that eight percent return or higher every year and again remember the strategy only works if the investment returns you get on average each year exceed the interest rate on the debt for your mortgage so if you're someone going out and getting a mortgage today when interest rates are you know six percent or seven percent then this is probably not the time to do this strategy you really want to do this strategy when you can lock in that interest rate at a very low rate and then expand the Arbitrage between their rate you get on your investment returns and the interest you have to pay over to the bank so I hope you found this video helpful if you did please subscribe to our Channel we have a lot of different videos out there on these types of topics that can really help you understand how to invest your money efficiently build wealth efficiently but not take on too much risk or take on you know unnecessarily risk that could get yourself in a lot of trouble so if you like the video please give the video a like and again subscribe to our Channel and stay tuned for more content on topics like this

Channel: Sharon Winsmith

Views: 6,688

Keywords: personal finance, real estate, buying house, pay off mortgage early, financial independence, how to make money, dave ramsey, mortgage payoff, the dave ramsey show, pay off your mortgage, paying off mortgage early, should i pay off my mortgage early, financial freedom movement, paying off mortgage early vs investing

Id: ZkVPV4E-SpM

Length: 17min 3sec (1023 seconds)

Published: Sat Aug 12 2023