PSA: Why it’s a BAD IDEA to pay down your mortgage early!

It's because of these reasons that's exactly why I will never pay down my mortgage early. If I have a 30-year loan, I will be making the bare minimum payments and just investing the difference versus ever putting an extra dime towards paying down that loan sooner than needed. What's up, you guys? It's Graham here.

So, contrary to popular belief, paying down your mortgage early could end up costing you tens of thousands or hundreds of thousands of dollars in lost profit. To prove this, I will be sharing with you guys some real-world examples to show you the math behind this. If you take the time to utilize this topic and fully understand it, it could very well make you six figures richer when it comes for you to decide whether or not you should pay off your mortgage early.

Now, most people just conventionally look at the cost of the mortgage over the term of the loan. Then they see that final number and feel like they're just getting ripped off. Then they just feel like they want to pay it down as soon as they can. So let's look at a very common example, which is a four hundred thousand dollar loan paid over 30 years at a four point two percent interest rate.

Now, over 30 years, on paper it looks like you're spending seven hundred and four thousand dollars over the course of the loan. This means you're spending three hundred and four thousand dollars in interest on a four hundred thousand dollar loan. Now, most people see this and they think, "Rip-off! Dislike! Unsubscribe!" From that, they conclude that it's probably better just to pay off the mortgage as soon as possible so they don't have to pay such high interest.

For instance, people might see the seven hundred and four thousand dollar total figure and get overwhelmed by that. Then just conclude, "Well, if I up my payments by a thousand fifty dollars per month, instead of paying nineteen hundred and sixty-five, I pay $3,000 per month, it looks like I will only pay a hundred and thirty-nine thousand dollars of interest over the course of the loan if I paid off early." This seems like the better deal instead of spending three hundred and four thousand dollars just for paying an extra thousand dollars a month.

In theory, they should be saving a hundred and sixty-five thousand dollars by paying it off early, but it's not the full picture. The reason why many people think this way is because they haven't really looked at the full cost of ownership: what they're really paying, what their money is really worth; and instead, they get hung up on seeing that final number, which is extremely misleading.

And here's why. So, in our four hundred thousand dollar example, your monthly payment is going to be nineteen hundred and fifty-six dollars. This means that, over the course of 30 years, you're gonna pay three hundred and four thousand dollars of interest. Those numbers are going to be our foundation from which we're gonna base all of our examples off of.

When determining whether or not it's worthwhile to pay off your mortgage early, there are three factors to consider. The first factor is the mortgage interest tax write-off. This is what makes real estate investing extremely attractive and also why it helps to keep a mortgage long-term.

On a primary residence, you can deduct up to the first seven hundred and fifty thousand dollars of your mortgage against your own personal income. Now when you have an investment property, you can deduct a hundred percent of whatever interest you pay against the rental income of that property. So, on a four hundred thousand dollar loan example in the first year, you've spent sixteen thousand six hundred and forty dollars in interest.

This means that for the average person in a twenty-three percent tax bracket, you can deduct sixteen thousand six hundred and forty dollars against your taxable income. This means that you can save thirty-eight hundred and twenty-seven dollars in taxes. This means that when you have a four point two percent interest rate and you're in a twenty-three percent tax bracket, you can lower the interest you pay by the twenty-three percent, effectively making that interest rate more like three point two three percent after your tax write-offs.

Because remember, you're taking the four point two percent interest rate, lowering that by twenty-three percent, and that gives you the three point two three percent interest. This is your effective interest rate you're actually paying after your tax write-offs.

The second factor to consider is inflation. Now, even though you look at the figure and you see three hundred and four thousand dollars paid over thirty years, you have to remember three hundred and four thousand dollars fifteen or thirty years from now is worth a lot less than three hundred and four thousand dollars paid today. Because the bank is holding the entire loan over the course of 30 years and all you need to do is pay bits and pieces over time.

It's pretty safe to assume that, overall, on average, we're probably gonna see about a 2% annual inflation rate. This means that even though you're only paying an effective rate of three point two three percent interest after your tax write-offs, when you also factor in inflation of two percent on average per year, you're really paying more like one point two three percent of interest.

Because remember, we started at a four point two percent interest rate. After your tax write-offs, we're more like at a three point two three percent interest rate; after inflation, that brings us to one point two three percent interest.

And the third factor now to consider is the opportunity cost of the extra money that you're putting towards your mortgage. The real question here is: can you make more than a one point two three percent return, adjusted for inflation, investing your money anywhere else than paying down your loan early? And the answer to this is pretty much always a yes.

The stock market has historically averaged about a seven and a half percent return adjusted for inflation. This means that if you prioritize investing over paying down your mortgage early, mathematically, over the term of the loan, you should come out ahead.

So, with the points I just mentioned, let's take two scenarios here. In the first scenario, we have a 30-year loan for four hundred thousand dollars at a four point two percent interest rate, which means your payments are nineteen hundred and fifty-six dollars. But you bump that up to three thousand dollars a month, so you can pay off in half the time, in 15 years.

Then after fifteen years, once the home is paid off, you will continue investing the same amount you're spending on the property, three thousand dollars per month, but instead investing it in the stock market for another fifteen years at a seven and a half percent return. When the thirty-year time span is up, this means that you now have a fully paid-off property.

You've invested 15 years in the stock market, and that will bring you to an average return of one million dollars. So after 30 years, you have a million dollars in the stock market and a completely paid off property.

But what happens if you don't pay down the mortgage early? What if you just keep the 30-year mortgage and instead of paying three thousand dollars per month, you just invest the difference? You put that extra one thousand and fifty dollars per month that you'd be spending paying down the mortgage and instead just, from the very beginning, invest it in the stock market.

But here's where things get really interesting. Now, because you didn't pay down the mortgage early and you instead just invested the extra money that you would have spent on the mortgage in an S&P 500 index fund that's given about a seven and a half percent return over 30 years, you'll have a paid-off home and you'll also have one million four hundred and thirty-three thousand dollars invested in the stock market.

This is four hundred and thirty-three thousand dollars higher than the person who paid down their mortgage after fifteen years and then just invested after that. That's an extra four hundred and thirty-three thousand dollars over 30 years just by not paying down your mortgage early and investing the difference.

Now, if I lost anyone here in these deductions, in very simple terms, this is exactly what I look for anytime I calculate the true cost of ownership for a mortgage. The first one is to subtract the deduction. Now, because you can write off the mortgage interest that you pay, this will save you in taxes. So, you basically just deduct whatever income tax bracket you're in against the amount of interest that you end up paying.

This often reduces the effective interest rate by twenty-three percent almost immediately. Now, could be even higher than this, or it could be lower than this depending on your tax bracket, but for average purposes, I'm just assuming twenty-three percent here.

The second one is, since the loan is long-term, you have to take into account inflation. Historically, we've averaged about a two percent inflation rate every single year. This means that every year your money is worth about two percent less than it was the prior year.

This is something that's extremely important to consider that not many people look into. This is also another reason why having a long-term loan is often keeping it as long as you can, because of inflation, and because that money is going to be worth a lot less in the future.

Now, the third thing to consider is investing the difference. Now, unless you have a really high interest rate of like six percent or higher, in almost every situation mathematically, you come out ahead by investing the extra money that you would have been spending paying down the loan early.

It's because of these reasons that's exactly why I will never pay down my mortgage early. If I have a 30-year loan, I will be making the bare minimum payments and just investing the difference versus ever putting an extra dime towards paying down that loan sooner than needed.

Now, don't get me wrong here because there are a few advantages of paying down your loan early. Even though mathematically in almost every single situation it's worth it to invest versus paying it down early, there are a few advantages, and this is what they are.

The first advantage that I see is that if you have a really high interest rate of maybe above a six percent or so, it's probably best just to pay off the loan sooner than investing the difference. This is because the upsides of investing just get smaller and smaller. The higher your interest rate is, at a certain level, the advantages of investing instead just become too small of a difference, and instead I would opt just to pay down the mortgage early, effectively just giving you a guaranteed rate of return.

Now, for me personally, if I had a loan above six percent, I’d probably just rather pay down the loan than invest. But if the loan is under six percent or so long-term, I would rather just invest my money instead.

But the biggest advantage here of paying down the loan early is that with our above examples, we assume the person is actually going to invest the difference of the money that they would be paying down in their mortgage. Now, unfortunately, probably in most situations the person is not going to be disciplined enough to actually invest the difference.

Instead, most people will probably just pocket the difference and then recklessly spend it on things they don't really need. We're not really investing the full amount, and this just totally negates the whole advantage of not paying down your mortgage early and investing the difference.

In order for this to actually work, the person needs to be dedicated enough to invest that extra money and not spend it. And I hate to say it, but probably for the average person out there, they're not going to have the discipline to do this, and it's probably a better idea they pay down their mortgage early. Even though mathematically they're going to be making less money, it's essentially just a guaranteed rate of return.

It's a lot safer than trusting them not to spend the difference, and this is far simpler for the majority of people to do. But I would expect that the average person who watches my videos is probably a little bit more financially literate than most, enjoys saving money, enjoys investing it, and therefore for the people who are disciplined enough, mathematically you should come out ahead by investing long-term over paying down the mortgage early.

That is if you could actually follow through with this and invest long-term. The next advantage here, paying off the mortgage early, is just peace of mind. Now, even though you'll make less money, just having the mental clarity of not having a payment is extremely freeing. This in and of itself could mean you have less stress; you're less worried, and even though you're not optimizing every single dollar, the mental clarity it gives you could be worth it.

Now, the next advantage of paying off the loan early is freeing up your cash flow. Now, even though this is a bit of a fallacy in that it actually lowers your cash flow by having your money tied up in a property instead of investing it elsewhere, it will make an immediate difference in the amount of money that goes into your pocket in terms of not having a mortgage payment and instead having all the extra money come directly into your pocket.

And again, even though this is a bit of a fallacy because technically this should lower your cash flow instead of deploying your money elsewhere, it does seem like an immediate benefit and, like I said, this is more about mental clarity versus trying to squeeze the value of a dollar from every which way possible.

Now, the last advantage I see is having this additional security knowing that you will own that home free and clear, without any sort of payment, no matter what happens to you. If you lose your job, if everything goes to [ __ ], if the market crashes, no matter what happens, you own that property outright. And again, this just goes back to the mental clarity of not having an extra payment and the freedom of knowing that you own that no matter what happens.

For many people, this is worth it entirely just to pay off the loan early. So, like I said, in most scenarios, it's more advantageous not to pay down the mortgage early and instead just invest your money long-term.

The only advantages I really see in paying down the mortgage early is if you have a really high interest rate or you just want the mental relief of not being burdened by a mortgage payment. But for anyone who actually has the discipline to stick with a plan to invest the extra money versus paying down the mortgage early, statistically and mathematically you will come out ahead by investing long-term over paying down your mortgage early.

I apologize if I lost anybody with these calculations. I did my best to try to explain it as easily and simply as I can, but if I confused any of you guys, just comment down below. I will be more than happy to try to answer as many questions as I can.

So, as always, you guys, thank you so much for watching. I really appreciate it. I really hope I didn't confuse too many of you guys. But if you guys enjoyed this topic, make sure to give it a like; it does really help out a lot. And if you've watched it all the way through, if you found this helpful and you haven't already subscribed, make sure to hit the subscribe button.

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