Should You Payoff the Mortgage(s) Early?

I haven't talked about debt in a while.

The reason is that we paid off our car notes and student loans over a year ago. We're feeling great!

The extra money we earned this past year went towards a down payment on a new house. But now that's over, we can start looking at our mortgage debt.

We ended up keeping our old house as a rental property, so our current debt load is these two mortgages:

  • Rental Unit – $150,000 – 4.875% – 29 Years
  • Home – $200,000 – 4.375% – 30 Years

Now that we've got some extra money rolling in again, I'm considering taking some of it and paying off our mortgages early. A couple of questions naturally arise:

Should we pay off our mortgage early? If so, which one should we pay off first?

Let's tackle these two questions. I will explain how I think about them and give you some perspective if you're making a similar decision.

Before I take on these two questions, I should note that we have:

  • an adequate emergency fund (i.e. money saved for a major medical issue that my high deductible plan can't handle, or colossal business failure),
  • we are maxing out my company's Solo 401(K), and
  • we've got some money saved for property and income taxes.

I think it's important that if we're going to start getting aggressive with the mortgage, we should be able to maintain progress on our primary goals.

As it stands, our extra funds could be used for taxable investing, more cash savings, more real estate investing, or, to pay off this mortgage debt.

Should We Pay Off Our Mortgage(s) Early?

My gut tells me we should. When I look at the combined mortgage debt above I get a little-unsettled feeling.

I know Mrs. PT does as well. Taking on more debt for another real estate property is out of the question too, even if we “cash flowed” like we are on our rental property.

More cash savings seems ridiculous at this point with interest rates the way they are and with our cash savings goals (emergency and taxes) met.

That leaves taxable investing. This is a tough one. I offer two different trains of thought on this issue:

  • Dave Ramsey is famous for saying “would you take out a home equity loan against a paid off house to invest in the stock market?” When you say it like this, I agree with Dave, I would not.
  • But Warren Buffet said he'd “invest” in a couple hundred thousand mortgaged single-family houses if he could figure out a way to do the maintenance. Warren is a smart guy and I should respect this advice, but I think it may come into play more when I have at least one of the mortgages paid off and some more money saved for retirement.

Being completely debt free including the houses would give us a huge sense of freedom and security, and I think that's ultimately going to drive our decision. Not numbers.

Which Mortgage Should We Pay Off First?

If we decide to tackle the mortgage debt, which should we pay off first? Our home or the rental property?

If you lump personal and business debts into one bucket then Dave Ramsey's snowball method (and the debt avalanche method) says we should pay off the rental unit first. It's got the lowest balance and the highest interest rate.

Mrs. PT likes the idea of being debt free on the home we live in.

My House Should We Pay Off the Mortgage

I like this idea too. Especially after you factor in the home mortgage interest deduction. Normally we should be able to deduct both the mortgage interest on the home loan (Schedule A) and the rental property loan (Schedule E).

However, this year we will probably reach the phase-out limit on the home mortgage interest deduction. So we could lose most of this deduction, which gives the rental property interest rate an advantage (i.e. we should keep it because we can fully deduct the interest on the Schedule E).

It looks like we'll start throwing extra dollars at the home mortgage first, and then reconsider things at that point.

Are you paying off your home mortgage early vs investing? Do you have two mortgages? If so, how did you decide which one to pay off first? If you plan to keep your mortgage debt for the life of the loan, how did you get comfortable with the risk and burden of debt?

Follow up: After this article we decided against paying off the mortgage early. Instead, we poured money into our Solo 401Ks (for both businesses). It's just so hard to pass up the opportunity to reduce our current tax burden.

Three and a half years later (when interest rates got really low) we ended up refinancing this loan from 30 down to 15 years at 3.5%.

We got a nice deal on closing costs and we thought this was a way of hacking the aggressive pay down of the mortgage. We figured if we weren't going to make extra payments we'd just force ourselves to make higher payments.

Two and a half years later (close to the time I'm writing this follow up), we decided to make some chunk payments over the next year to pay down the mortgage in full. It's time. Both businesses are rocking right along, we've overloaded our tax-advantaged accounts for a couple in their late thirties and early forties. It's time to just get rid of the mortgage once and for all.

We'll be making three chunk payments. One this April 15th (to ensure we're all caught up on taxes), one this Fall shortly after the results of FinCon are in, and one next April 15th (once another tax payment has cleared). That said, it looks like we'll be mortgage free next Summer. I'll be sure to follow up once we do.

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  1. CanadianBudgetB says:

    We are 3 years into a 25yr term mortgage and we’ve saved enough to pay it off now. Question is just what you are asking, do we pay it off or invest. That’s a hard question to answer so I think we’ve decided to pay it off, get it out the way and take the money we will save every month and start investing and saving that. Where’s that crystal ball… I need it. Cheers and great post. Mr.CBB

  2. Can you not consider your rental as your home in the future god forbid something bad happened and you lost/gave up your home. Therefore freeing up your mind to just go on best numbers? Just curious.

  3. Interesting analysis Phil.  Great methodical approach and a good read for others considering paying off a mortgage.

  4. And suddenly a hashtag is born! 🙂 #FinNews
    @ptmoney @applecsmith

  5. @bowaterecu Thank you for the RT!

  6. @annuityearl Thank you for the mention yesterday!

  7. kwmccarthy says:

    If you ever listen to Dave Ramsey or read his books you would know that the snowball method does NOT apply to mortgages that are more than half your income (personal or rental homes).  Also, if you called in to his show he would tell you to pay off your personal residence first! You would rather the bank take your rental from you than your personal home if things went bad.

  8. Payoff your home first.  I currently have a paid off home, plus one rental unit with a $120k mortgage.  We’re working to pay that off next.  The “number people” may tell you that money is cheap right now and to pay off neither, but those people probably haven’t experienced a mortgage free life.  Take it from me…when you live in your home debt-free:  the food from the kitchen taste better, the air smells sweeter, and the st. augustine grass feels better between your toes.  You truly can’t put a price on it.  Few people have a chance to payoff their home, so go for it PT!   You have plenty of future decision you can make based on “the numbers”.  But go with your gut on this one…it’s leading you to a peaceful place, I promise. 

  9. @GRSblog @ptmoney I didn’t realize you couldn’t do both at the same time.

    • @desluna It’s more of a “would your rather” type of question. Of course, your mortgage gains interest.

  10. joetaxpayer says:

    If you are in the phase-out range for itemized deductions, then losses on the rental may not be deductible either, they just carry forward. At least until the place runs positive, then those losses are used up.
    I’d slowly tackle the higher rate, I suppose.

    • Philip Taylor says:

       @joetaxpayer Good point about the rental deductions. My Dad, CPA, asked the same thing. But I should be running a gain from my rental unit (it’s cash flow positive), unless I don’t understand how much the depreciation will affect things. Something my CPA will look at before the year ends. TBD.

  11. @payoff @ptmoney if I could, I would; why not?

    • @Orly7581 @ptmoney Paying off debt is tough, but not impossible!

      • @payoff @ptmoney you are right; I wish there are better options, interest rates on debt kills me.

    • @Orly7581 @payoff Math and history says the money might be better spent investing. But it’s a personal choice. I’m choosing to pay some off.

  12. . @ptmoney I’m glad I’m not in your shoes; I’d not be able to sleep if I owe so much. Me? focus intensity -house #1 paid for, working on #2

  13. fully think being debt free is way to go…i’m tired of being a slave to the lender.  we are aggressively paying off our mortgage just to be free from anyone owning a piece of our pie…one day, i hope to buy some real estate with cash and use the proceeds to buy the next one.  
    as for your case, i think it is six one way half dozen the other … i’d probably attack the smaller one first, simply because you could always move back in it if you had to.  i’d also consider refinancing them … you might get 15 year loans that would be comparable PLUS pay more principal.

  14. Personally I am leaning toward not paying off my mortgage early as well.  With my low interest rate combined with the tax write-off, I think I can get better results investing elsewhere.  When this no longer becomes the case I will reconsider.  However, I agree that I would not throw more money at rental property at the moment if you are not planning on that being your main source of income.  It would be a better idea to diversify at this time for some security.

  15. krantcents says:

    Normally, I would never payoff my mortgage early!  I am paying off my mortgage early to coincide with my retirement  in 4.5 years.

  16. Money Life and More says:

    I’m really leaning toward NOT paying off my mortgage due to inflation. I think it’d be awesome to pay the same mortgage payment in 25 years when things cost 2 or 3 times as much. My thought process may change one day though and my mortgage payment is ridiculously low.

  17. Hi PT – I would first consider refinancing both mortgages. I just did my primary home refi to 2.625% for a 5/1 ARM jumbo. I refied my rental property last year to 3.375% for a 5/1 ARM. I’m sure you can lower your rate!
    I’d also just go with your gut and throw money at your mortgage whenever you feel like it over a period of time. Liquidity is good!
    Thx for finding my post.
    Cheers, Sam

    • Philip Taylor says:

       @Yakezie I guess I need to take a second look at the risk of ARMs. That is a good rental property rate. If I refi-ed mine I’d lose my personal residence rate and would have to go ARM to beat it. Ultimately I think I’m just ready to be rid of the hassle of debt.

      •  @Philip Taylor I am a STRONG proponent of 5/1 ARMs and ARMs in general. Take a look at a 30 year chart of the 10-year yield. It’s been going straight down!
        If I could borrow at 1 month libor I would! Sam

  18. AverageJoeMoney says:

    It’s interesting to me that the decision to pay off the mortgage early isn’t a numbers decision but a feeling one, yet “which” mortgage you pay off first is a math equation. Why the change?

    • Philip Taylor says:

       @AverageJoeMoney Good point. Well, even though I said gut, you could really say it was math I guess – my debt to asset ratio is too high. I guess I’m just ignoring the invest % vs debt % math. In the second question, we’re following both math (mort int issue) and gut (desire to live in a debt free home), and actually ignoring the snowball/avalanche math. All that to say, it’s a mix of things. Ultimately I don’t think it matters much. Financial freedom is in our future. It’s just a matter of which road to take. Both roads have about the same distance. One’s more scenic? Okay, I took the analogy too far there.

  19. William_Drop_Dead_Money says:

    It’s a question I ponder often. Given that I’m earning at least 6% on dividend stocks and my mortgage interest is less than that, I’ve opted to keep both and pocket the difference. The difference isn’t a lot, though, so I’m still on the knife’s edge. What’s tipping the balance is the question of whether or not inflation’s going to take off. If it is, I want the capital to purchase another house to get the appreciation benefit.

    • Philip Taylor says:

       @William_Drop_Dead_Money I think what we’ll do William is probably pay off our home and then build downpayment money for another rental. Great idea that ties back into your inflation post from last week.

      •  @Philip Taylor  @William_Drop_Dead_Money 
        “probably pay off our home and then build downpayment money for another rental.”
        @PT this makes no sense to me.  Rates and homes are at historic lows and you are going to wait what could be years because the debt feels “icky”? It would make sense to me if you weren’t looking to take on additional real estate, but if you found a cash flow positive unit you could then deleverage over the next decade as rates increase. 

        • Philip Taylor says:

           @MJTM  @Philip Taylor  @William_Drop_Dead_Money  @PT “what could be years” Who said it would be years? What if it’s 6 months? 🙂 I think having one paid off property changes everything.

        •  @Philip Taylor  @William_Drop_Dead_Money  @PT 
          Yes, I think if it is 6 months that changes my answer.  But that is a whole lot of debt to pay off in 6 months! lol