Another point-of-view of mine that will either result in my wrist being slapped or will result in some more logical decisions: The quest to be mortgage-free is completely over-rated and, often, a detriment to improving your personal net worth.
This is for two reasons:
- Mortgage payments generally don’t take up too much of an individual’s after-tax net income, and so the idea of there being a cash windfall upon payout of the mortgage is mostly a myth.
- Mortgage payments, late in their amortization schedule, are made mostly of principal payments and act as a forced savings greater than an individual’s own sheer will.
Let me explain.
The Mythical Cash Windfall
Banks are specifically regulated to ensure they do not give out too much of a mortgage for a borrower to handle. The calculations lenders go through are fairly extensive (or, rather, the computer goes through extensive calculations while the lender punches in the numbers — take your pick), pretty onerous, and pretty eye-watering. The onerous calculations and ratios are there to ensure you do not have more to pay back than you can reasonably handle.
As such, a mortgage payment, more likely than not, will only take up $XXX of your overall disposable income on a monthly basis. At the end of the year, if you add up your mortgage payments, I personally doubt they’ll amount to a sum you’d consider a cash windfall.
If you make $1,000 monthly mortgage payments, mortgage-free life would leave you with $12,000 of extra cash in a year. It’s easy math.
I’m not saying $12,000 is nothing. There are many folks who would love to have an extra $12,000 each year.
But I also know that $12,000 doesn’t change anyone’s life. You can spend $12,000 on a 10-day trip to Hawaii. You can spend $12,000 on a camera and a couple lenses.1 You can spend $12,000 on a down payment for a relatively nice vehicle.
As a whole, the required cash outflows for a mortgage will likely not change your life when you finish paying off that mortgage.
I love forced savings. If, at the end of my financial writing here on The Newsprint, you don’t understand that forced savings is the kingly method of saving, then I’ve failed.
Forced savings are the best savings.
It’s pretty logical to understand that the last few years of any mortgage carry less of an interest burden and more of a payback on principal. If you have that same $1,000 mortgage payment, more than $900 of that amount will go as direct pay down of the principal of the mortgage in the mortgage’s later years.
Ultimately then, once the mortgage is paid off, will you save that same $900+ each month? Or will you divert it to consumption and other less-productive spending?
Debt payments, in the early years of a loan or mortgage, are an expensive way to introduce forced savings into your life (essentially, you’re paying an interest premium for the sake of forcing yourself to save). But in the latter part of any loan or mortgage, they are fairly cheap ways to force yourself to save.
My thought: As soon as that mortgage is paid off, get another mortgage and buy more property — but this time, rent that property out. You may not see any extra cash in your bank account, but rest assured, someone else will effectively pay your mortgage for you.
Or you could borrow against your newly paid-off house to invest in dividend-paying shares — if you can find monthly or quarterly dividend payments that are enough to make interest and principal payments on the borrowed money, you’re able to take part in growth of the share price for free. Plus, the interest is deductible for tax purposes (which, in Canada, the mortgage interest on your principal residence is not deductible for tax purposes), ensuring the tax man pays for at least 25% of your borrowing cost.
So my thoughts, in short, are: Being mortgage-free is over-rated because banking regulations require your mortgage payment to be a small amount in relation to your overall income and because mortgage payments are a great way to force yourself to increase your personal net worth on a scheduled basis.
Obviously, being mortgage-free and debt-free at some point in your life before retirement is a healthy goal — I certainly don’t want to be going into retirement with a mortgage. But, debt payments can be a great tool for forcing yourself to improve your personal net worth, especially when those debt payments are for assets that grow on their own.
You could buy a Leica M10 plus half a Leica M lens for that money. ↩