Though I’ve written posts on this subject before, sometimes my zeal to spread the word is renewed by contrary opinions. Of course, when it comes to how folks feel about this subject, you find that very little real analysis was used. I think the problem at times is exactly what analysis is done. Most folks will say putting their money into the bank for a 2-3% return is inferior to paying down their loan because if the interest rate is say, 6%, then that’s what their money is earning. True enough. But that’s the wrong analysis to say the least.
Since it will take literally hundreds of thousands of dollars to pay off that very loan, why not take all that money and grow it at 3-10 times that rate? How you look at this question could very well determine whether you have a great retirement or live out a self-imposed life sentence.
My own grandpa passed away 15 years ago. He was a well known artist, one of those rare breeds who made a decent living while still alive to enjoy it. His paintings still sell for $5-30K apiece. He painted until his health went down hill. He was in his 80’s. It’s a good thing because he and Grandma had their monthly Social Security check plus money from sold paintings. They worked hard to pay off their home loan, which was under $20K upon his death. Yet they would have been behind the 8-ball if he hadn’t been able to continue painting as long as he did. They were inches from having their Depression-based dream of a free and clear home.
Grandma couldn’t afford to live there when Grandpa died. (Though she still would have moved due to her age & heath.) She had to rent out the house to supplement her income, while moving into one side of a duplex next to one of her kids. She was now renting, while owning her home which was just about debt free.
And she and Grandpa did this on purpose.
They lived a frugal life. Their only travel was to destinations Grandpa painted, or to see family. They typically owned their car for at least a decade. They did everything right — including paying that loan down like crazy. I remember literally begging Grandpa to let me at least get them some discounted and very safe trust deeds. It was like I asked him to join the local chapter of Hell’s Angels.
And when he died Grandma had to move because they’d been successful in executing their life-long plan.
So I pose the question: Which would you prefer — to retire with a free and clear home, an under-funded 401(k) and Social Security OR $150K in annual retirement income, most of which is either tax deferred or tax free but with a $3,000 monthly mortgage payment?
Take your time. No rush.
That choice is comparable to the one I gave my son during college. Would he prefer to earn a spot on the honor roll 100% of the time thereby receiving the pink slip on a perfect condition 3000 GT SL upon graduation OR not stay on the honor roll 100% of the time and continue to drive the zillion mile piece of doggy do-do he was currently driving?
I told him to take his time. No rush.
A retirement based upon a free and clear home with Social Security and a horribly under-funded 401(k) (or IRA for that matter) isn’t a retirement — it’s a life sentence. And a myth leading good folks down the path of a miserable retirement.
And you won’t know it until it’s too late.
Ask yourself what you could have done differently over the years with the several hundred thousand dollars you put into principal pay down on your home’s mortgage. After all, every dollar you dropped into that loan’s principal reduction earned you a whopping 6% a year.
You think maybe your capital might have earned a touch more than 6% a year?
Please say yes.
Benjamin says:
Hey Jeff
The white paper is GREAT – I finally had a chance to read it last night.
We’ll talk today about it… I’ll give you a call
BE Great
Benjamin
March 3, 2007 — 5:32 am
CJ, Broker in L A, CA says:
Jeff, you’re in luck. One of our clients loaned me their “Transforming Debt Into Wealth” workbook… and I’ll copy a few sentences from the workbook here, so you can answer them:
QUOTING: “Each dollar of interest you pay the mortgage company is deductible from your taxable income. Assuming you are in the 28% tax bracket, that saves you the 28 cents you would otherwise have paid to the government on that dollar as income tax. But think about that, you are giving up a full dollar to save 28 cents. Whereas if you pay off your mortgage, you will indeed have to pay 28 cents federal income tax on each dollar not spent on mortgage interest … but you are getting to keep the other 72 cents. Ask yourself, would you rather pay a dollar in mortgage interest to save 28 cents, or pay the 28 cents in taxes to keep the dollar?” /END QUOTE
March 3, 2007 — 5:59 am
Jeff Brown says:
Thanks Benjamin, I look forward to hearing from you.
March 3, 2007 — 10:27 am
Jeff Brown says:
CJ – I love this – Thanks for teeing it up.
>Ask yourself, would you rather pay a dollar in mortgage interest to save 28 cents, or pay the 28 cents in taxes to keep the dollar?”
Is that the real question though?
Isn’t the real question – Are you trying to save money or make your dollars grow?
The short-sighted analysis says by paying off your home’s loan early with after tax dollars saves you the monthly payments in retirement, and in the few years before retirement.
I tell my clients to take their investment capital and, instead of applying any of it to their home’s loan principal, invest it in income property located in a growth region. Why?
If you find a property that will break even or better with 10-20% down, and it averages only 5% annual appreciation, that capital is now growing at a rate of 25-50% the first year, and nearly that the following years.
That return doesn’t include the taxes saved through depreciation every year. And when the property(s) grow enough you can then move up to even more property, essentially recharging your growth rate until it’s time to do it again.
Let’s review. You can put your dollar into your home loan’s principal and make roughly 6%, or you can earn 25-50% for the next 10-30 years. Do it the investment way and you’ll end up with a home loan payment and a net worth requiring two commas.
Your choice. No rush. Take your time.
Thanks CJ.
March 3, 2007 — 10:42 am
Jay Matthews says:
Jeff,
Great post on a detrimental (and generational?) belief that played out for many people’s grandparents and great-grandparents exactly the way it played out for yours.
March 3, 2007 — 4:32 pm
Jeff Brown says:
Jay – Thanks! If it wasn’t for the family making sure Grandma was taken care of like a queen, it might have been unfortunate.
It’s still happening. The kids of Baby Boomers might be in for a rude surprise when mom and dad reach retirement.
March 3, 2007 — 4:51 pm
Michael Cook says:
I totally agree with everything you said here Jeff, but the question is do you really feel like your grandparents had the understanding to invest in an IRA or trust deeds without your help? The only bad part of analysis like this is that it assumes people have knowledge of their investment options that I really dont think everyone has. Heck, even with an MBA in real estate, there are plenty of investment vehicles that I dont understand.
People who work at jobs that dont provide a 401k (probably over 50% of the population) have to be savvy enough to find their own investments. Even a tax deferred IRA may not get them that much better off. I think the people that your advice targets may not have the capacity to execute your strategy.
My parents give me the same reaction when I try to suggest better ways to invest their money. Its not that they dont want to earn better returns, its simply that they just dont understand it or have been burned by investments in the past. I solve this problem by simply asking them to loan me money and agreeing to pay them back a competitive interest rate.
But what about the parents without kids, who know what is best for them? You can tell them all day they are better off doing something, but if they dont understand it, they will stick with what they know (savings accounts and cds). Paying off a mortgage is better than this.
March 3, 2007 — 5:23 pm
Jeff Brown says:
Michael – Thanks for the comment.
The assumption is, of course, they don’t know what questions to ask. That said, when they fear something is wrong with their health, they go to whom they know will have answers to questions they don’t know to ask.
You’re right about our parents and grandparents lack of knowledge on the subject. But your parents and grandparents told you the same thing mine told me – ignorance is no excuse. I think the real problem is also in your comment.
They know what they know and are just plain afraid.
Paying off the mortgage, in the end, only gains them a few years before the hammer hits. At some point they’re financially dead in the water, in some cases without the ‘life guard’ of a caring family.
They need professionals like us to be able to successfully communicate the depth of water in which they’re swimming.
We need to be evangelists. 🙂
March 3, 2007 — 5:40 pm