Should I Pay Off My Mortgage or Invest? (We Did the Math)

Mindy:
When you’re on the path to financial independence, there’s this big debate, should I take this money and pay off my mortgage or should I take that money and put it in the stock market? So today Scott and I are going to have a lively debate because one of us feels like you should keep your money in your mortgage and the other one thinks the stock market is the way to go. Can you guess who is right? Me? Alright. Hello, hello, hello and welcome to the BiggerPockets Money podcast. My name is Mindy Jensen and with me as always is my totally wrong about mortgages, but I still love him. Anyway, co-host Scott Trench.

Scott:
Thanks, Mindy. Great to be here at this topic is of simple interest to me and I look forward to discussing it with you today.

Mindy:
I love it. Alright.

Scott:
Oh, that’s right. BiggerPockets has a goal of creating 1 million millionaires. You are in the right place if you want to get your financial house in order because we truly believe financial freedom is attainable for everyone no matter when or where you’re starting, including whether you have a mortgage and can’t decide whether to pay it off or invest. In this episode, we’re going to talk about how you should be looking at your portfolio to determine when and if paying off your mortgage is ever a good fire decision and whether the fire math supports that. We’re going to discuss a quick refresh and how to calculate your FI number. We’re going to talk about how to determine when and where some folks may consider paying off their mortgage or not, and we’re going to discuss how that can affect your timeline to financial independence. So Mindy and I obviously disagree. A lot of this will be a debate. Mindy, I would love to open this up by hearing why you shouldn’t pay the mortgage. I think you have prepared a lot of math and a big argument for that, which I will dissect shortly.

Mindy:
Okay, so I have actual real life examples for why you should not pay off your mortgage. But before I give that, I want to caveat this is only for people who are considering paying it off versus considering keeping it. If you have financial trauma in your past that just does not allow you to sleep at night without having a mortgage paid off, then this conversation is not for you. This conversation is for the people who truly aren’t sure should I pay off my mortgage or should I invest? So Scott, my true life story, I was born in a small town. No. Okay, fast forwarding to 2019, back when interest rates were still really low, I was able to purchase the house that I am recording from right now for $365,000, which was a huge discount because it was gross as my houses tend to be.
It was a smoker’s house. So they had smoked in this house for 40 years. The carpeting was just holding in all this stuff. It was horribly outdated and nobody wanted this house, so it was already sitting for a long time. The sellers were getting very anxious and in order for me to be able to get it for such a reduced price, I had to be able to close quickly. So I rated my 401k in the form of a loan, not in the form of cashing it out. I rated my 401k, my husband’s 401k. I got a line of credit on my other house that I had been living in and I sold a collectible car to gather up all the cash so that I could pay cash for it and close very quickly.

Scott:
You didn’t sell your Tesla stock?

Mindy:
I sold my Acura NSX. Got

Scott:
It. Okay.

Mindy:
I think we sold Tesla stock to buy the Tesla car. But anyway, so we bought in September of 2019 and then six months later we cash out refinance. We pulled out 80% of the value of the home and grabbed that cash. So now we have a mortgage. Our mortgage is at 2.875 and I know that interest rates have gone up, but this is what happened with me. So we pulled out $319,000 and since then we have paid $31,500 in interest approximately, but we took that 319, we put some of it back into pay off the 401k loans. We invested $152,000 in a variety of things. That 152,000 is now worth $322,000, which is a gain of about $170,000. We invested mostly in funds like V-T-S-A-X and VGT, which is Vanguard’s tech fund. We also bought 40 shares of Tesla. Now Tesla has far underperformed the funds including V-T-S-A-X, but V-T-S-A-X has far underperformed the VGT that we put it in.
If we had put it all in V-T-S-A-X, we would only be up $140,000. And also note that we took that 150,000 and paid off the line of credit and the 401k ones and all of that. So if we’d invested the entire 319,000, we’d have a whole lot more, but we would also have paid a lot more interest because the home equity is a variable rate and we were just like, yeah, I want to close this out, pay this all off. So I am up $170,000 simply because I have chosen to have a mortgage and actually if we’re going to be fair, I’m up 140,000 because I’ve paid 30,000 in interest. So that is my argument, Scott. But I’ll also caveat that I have heard people say, oh, the reason that I want to pay off my mortgage is because if I didn’t put the money into the house, I would spend it and I’m technically not spending it. I’m investing it. Alright

Scott:
How are we doing? Is it time for me to react to

Mindy:
It? Is time for you to react?

Scott:
Let’s get something off the books immediately. If you pay off a low interest rate mortgage and the stock market, for example, an index fund returns anything close to what it’s returned over the last a hundred years on a go forward basis, you will have less wealth at the end of 30 years paying off your mortgage than investing in the stock market. So no one is arguing against that. The only way you’ll have more wealth paying off your mortgage is if the stock market goes nowhere over the next 20, 30 years, which I don’t believe. So my argument is not for how to amass the largest net worth number. My argument for paying off the mortgage has to do with the math of fire. So let’s use your mortgage specifically as an example. Here you have a mortgage of $319,000, right? Okay, 319,000 and I believe you said the mortgage rate was 2.875%.
Okay, so your monthly p and i payments are $1,324 $1,324 times 12 months times 25, which is the 4% rule. So a big implicit assumption here. Here I’ll actually take one step back times 1,324 times 12 is $15,888 per year. Now to fire one typically needs, the rule that we always come back to is the 4% rule. So one would need 25 times $15,888 from their portfolio in order to comfortably retire using the 4% rule, that implies a balance of $397,200 in your portfolio of stocks and bonds. In order to distribute the $15,888 per year you need just for p and i. So if you’re close to fire, you don’t have this problem because you’re so far past fire, you have so much more wealth than you need to feel comfortably retired that you can just optimize for even longer term wealth and not ignore this problem in general.
But someone who is close to FI would accelerate their journey by paying off the $319,000 mortgage even at that 2.875% range early because it would reduce the total balance of wealth they need to fire by $70,000. How’s that for some interesting fire math here? Now that gets even more extreme. Obviously you have a low interest rate mortgage, but if you have a 7% mortgage, let’s do the math here for this one. So that’s a $2,122 p and i payment. So 2,122 times 12 times 25 is $636,000. So paying off this $319,000 mortgage balance at 7% accelerates your FI journey by an incremental 320 some odd thousand dollars. And that is the phenomenon that really has been interesting to me over this time is yes, there’s an opportunity cost in 30 years, someone may have less wealth, but is even that opportunity cost as big as we think?
Because when we think about the fact that someone needs to generate $25,000 per year on that $319,000 mortgage at 7% for example, is the opportunity cost with the stock market really that large, right? There are tax considerations. One has to factor in here in order to generate $25,000, one has to realize income in some form, whether it’s a capital gain or dividend or ordinary income going in the most conservative case, a capital gain might be taxed at a 10 to 20% rate. For a fire person that’s probably going to be in the higher end of that range, let’s call it 20% plus your state tax, four or 5%. So now your 10% stock market return is really only 7.5%. So you have to generate a 10% pre-tax return to pay the 7% tax rate on your mortgage, a 7.5% return that’s highly volatile in the stock market and maybe not certain, maybe not something that you really want to plan on or guarantee yourself.
That’s not enough of a spread for me to pay off. It’s compared to a guaranteed reduction, a guaranteed 7% interest rate on a mortgage and following that math, the house I’m sitting in and recording this podcast from is one that I purchased this year and I chose to not use a mortgage. I chose to just buy it in cash instead of investing in the stock market or an alternative because of that concept here. If I was going for the largest possible long-term net worth number, no way would I have done that. I believe I could have gotten a spread in real estate or something else compared to buying this house, but I have peace of mind a guaranteed return here and it’s a two-way door. This rescission is not irreversible. I can always take out a mortgage if interest rates go down in the future and reinvest that in something else like real estate stocks or an alternative.
So that’s my fire math. I think I have two more points here and then I’ll shut up on my monologue. I think that I want to caveat this as if I was starting over my journey to fire, there is no way that I would say, oh, I’m going to buy a house and pay down my mortgage, right? This is not a good tactic for someone starting on their journey. But I think that for someone who’s close to fire, even if they have the 2.85% mortgage, that paying that off may be the thing that actually moves them over the edge and gets them comfortable with financial independence. There is a model that I need to build here to calculate that. I wanted to have it done for today, but I didn’t have a chance to do it and sometimes I’ve delayed on these types of discussions for months and months and months until I actually get around to building this thing out. But I know that once I build that and model it out, that it will show that a new person starting out from zero or the first a hundred, 250 k and looking to move toward fire should not pay off their mortgage if they want to maximize their chance of getting there quickly. And I know that people who are close to fire will be able to finish the journey per the 4% rule a little faster in many cases if they choose to prepay their mortgage. So how’s that for,

Mindy:
I hear what you’re saying and I have some questions.

Scott:
Alright. We do have to take a quick break to hear a word from our sponsors, but when we return, we’re going to continue getting into the nerdy pre and post-tax math of paying off your mortgage versus putting it into alternatives like high yield savings accounts.

Mindy:
Welcome back to the BiggerPockets Money podcast. Let’s jump back in. So first off, you said if you were just starting your journey, you wouldn’t pay off your mortgage, but if you’re close to fire you would. What does close to fire mean in this conversation?

Scott:
Let’s go back a couple weeks to Emily and Justin from the middle class trap episode here. I think that was episode 5 43 of the BiggerPockets Money Show podcast. So we’re talking to them, their $1.5 million net worth. Their mortgage is probably in that 2.85% range, maybe a little higher, maybe a little lower, but in that low interest range. And they’re like, how do we get out of this portfolio that’s not producing any cashflow or lessen the pressure on ourselves to just earn a bunch of income? Well, that’s a really compelling position or really compelling situation to say you should just pay off the mortgage potentially, because if the goal isn’t the highest possible long-term net worth, but the feeling of financial independence and unlocking bits of the portfolio, that’s an easy lever, right? That unlocks 20 or 25 years potentially of a lower demand for income generation for that during the best years of your life, you have a lot less pressure on your household to generate income to maintain a cashflow positive situation.
So I really like that. Also, I want to call out that some folks run the opportunity cost on paying off the mortgage incorrectly because they’ll say, oh, you take that 300,000, you invested in the stock market and you get this huge number. Well that’s not a fair comparison because what you’re doing is you’re taking that 300,000 and you’re prepaying the mortgage, but then every year, Mindy, you can invest the $15,888 in the stock market. So you get a good chunk of it back. There’s still an opportunity cost at the end of it, but it’s not $300,000, three $19,000 compounding at 10% for 30 years versus nothing. You can still invest in the stock market on the alternative there. And so it’s a much lower spread than a lot of people compute back at the napkin in terms of that opportunity cost. So anyways, in that situation, I think there’s a very good argument to be made for paying off the mortgage, and I think that argument is only that much more powerful for folks like me who bought a house in 2024 or 2023 with the higher interest rate environment.

Mindy:
I will give you that. The higher interest rate environment would definitely give me a different thought process. And you said something, it isn’t 319,000 versus nothing and think that’s really important to point out. I think a lot of people don’t calculate these numbers correctly. They think in terms of absolutes it’s either 319 or it’s nothing. And that’s not true and I am just as guilty as anybody else of thinking in more absolutes. Scott, what is your opinion of taking the difference? Let’s use my $1,324 a month PI payment and let’s say I wanted to make a $1,500 a month payment in order to pay that off. What is your thought of making the 1324 and then taking the 1 76 and putting it into a high interest checking account or a high interest savings account so that I have access to the money, I’m still making this additional payment, I’m just not paying the mortgage company that I am making more an interest. Now somebody pointed out that you are going to pay taxes on that interest.

Scott:
Yeah, that’s my big problem. So in Colorado, someone who has the ability to generate $319,000 in cash is likely in a moderate to high income tax bracket. So someone who has the ability to make this choice, which is most of the people who we’re talking about on this episode, a third of the people listening to BiggerPockets money are millionaires and are likely to have some version of this problem in their lives. So this is not for everybody. This is not for somebody who’s starting out. You’re like, oh, privileged to discuss paying off the mortgage or investing. This is for folks who have the choice to make there, but let’s say your household, Mindy, you’re talking about this, you’re going to earn 5% if you’re doing a good job in your high-yield savings account, that would be a good high-yield savings account. You have to probably move your money pretty frequently to sustain that because they always dip and dive in various banks.
I think Ally right now in my account is like 4.75 or something like that. But let’s say you’re good and you get 5%, okay, in Colorado, the highest tax bracket is 43.8%. When we blend federal income tax, state tax, Medicare, Medicare and Medicaid, and then social security. Okay? So that is going to cut your return from 5% to a little over 2.