Convergent Financial Group
m&m's: chatting about markets & mortgages
My wife, Kristy, has hijacked the blog for a good cause again. Here she is...
Well I prefer the chocolate variety of m&m's personally, but today we are talking about markets and mortgages. This is something I hear people ask Jeremy all the time: Should I pay off my mortgage or should I invest? And taking that one step further, to speak to the markets of recent: Should I focus on paying off my mortgage instead of investing while the markets are down?
I sat down for a chat with Jeremy and asked him what I hear others asking on the regular. If you've been reading our blog for a while, you know we've talked about this before. But today we're going to dig a little deeper because I still had questions, and maybe you do too. Let's see if we can get those answered...
( J = Jeremy, the financial expert; K = Kristy, expert in other things, let's say )
K: One of the most common questions you get is about balance between saving & investing and paying off a mortgage. In times like the present, when markets are down, this seems to come up even more often… In particular, people are wondering if they should change their current strategy with regard to investing and mortgages. What are your thoughts about that?
J: The first question you’re asking is, “Should I put my extra money into paying off my house or should I invest it?” The answer is that you should invest.
K: Okay. Why?
J: I believe that owning a house and paying a mortgage, especially with the interest rates we’ve had for the last 10 years, is a cash flow decision. When you owe on your house, you’re going to have a period of time that you’re always paying that expense whether it’s $1000, $1500, or $3000. If the house is paid off, most people don’t use the money they’re no longer paying towards the house to save. They just spend more. So when you invest you are using money to make money. When you pay down your mortgage, you are just saving the amount of interest on the mortgage… that’s it.
Most people don’t realize that 30-40% of your mortgage cost is going to remain whether your house is paid off or not because of taxes and insurance. So I believe that the best thing to do is put your money in the market so it can work for you.
K: So during healthy market times, I see how that makes sense because you can make more in the market than you would be saving by not paying the interest on your mortgage. But in a down market like we’re in now, how can what you’re saying still be true?
J: That refers back to the second question you originally asked. My response is that you’re looking at it very short-term… a period of a month vs a long-term period like 30 years. So let’s say you’re thinking, ‘Hey, I can save myself 3% interest by putting $250 extra towards my mortgage each month instead of buying $250 worth of stocks at a reduced price each month.’ Over a 30-year period, you’re going to come out far better by investing in the stock market.
K: So it’s basically like buying in while it’s on sale so you get to experience a greater appreciation? If someone waited until the market got better to get in, they are now paying more money for the same thing?
J: Yes, they would be paying higher prices for the same thing. Think of it this way, whatever the market price is today, 30 years from now it’s going to be a lot higher. The amount of interest that you’re paying on your house today is going to be basically the same for the duration of your mortgage. So just using basic math, if long-term investments are going to give you about 7-8% rate of return and a mortgage will cost you 3-5% interest, the math says it's better to invest in the market. Especially if the market is pulled back.
K: "Pulled back" meaning it’s slightly down relative to the short-term?
J: Yes. So what’s happened right now is that a lot of people are saying, “Hey, listen, I don’t want to lose any money. Every time I put money into the market, it seems like it’s going down. Why don’t I take that investment money out and put it into something that’s guaranteed — like my mortgage?” That’s exactly the opposite of what you should be doing. If you did that, you’d be missing out on the lower entry point into the stock market.
K: That makes sense. But I noticed that you mentioned an investment period of 30 years. Well, you and I are both 40 years old, and 30 years from now—
J: We’ll be 70!
K: Yeah, and I’m hoping I won’t be working and still saving, but will be living off of the money we’re saving and investing now. So does that matter? Would your answer be different for someone who is retiring in 10 years vs 20 years vs 30 years, for example?
J: No. When you pay off your mortgage, you’re not really saving money. You’re not paying interest payments. Those are two different things. When you put dollars into your house, you’re putting money into your home equity. It’s not a savings. You’re only not spending the amount of interest you’d be paying the bank. When you put $500 into the stock market, that is saving. That’s an asset that you can easily turn into money and actually spend if you want or need to—
K: But, Jeremy, you always tell me (when I want to buy something and justify it because it’s on sale), that we don’t save money by spending less. You say we save money by not spending. Period. And not spending on your mortgage seems like you’re saving.
J: It does seem like it. There’s validity to the idea that if you’re not paying on a mortgage, you’re saving by not paying that money back to the bank. BUT!… what I see happen in reality is that it doesn’t turn out that way. Here’s why: let’s say Jack & Jill have have a mortgage payment of $2000/month. They put all of their extra money towards paying that mortgage off faster. All of a sudden, they no longer need to put $2000 towards their house every month. They only need to put $700/month towards taxes and interest. That leaves them with a decision to make: What to do with the extra $1300 they now have each month? In theory, people tend to believe that they would begin saving and investing that money. But what I see happen in reality is that only the most disciplined actually do that. The vast majority of people take that extra money and just increase their lifestyle without changing their savings/investing rate at all. So, in the end, they would have been better off keeping their mortgage and continuing to save and invest all along the way. Again, I’d refer you back to the basic math we talked about earlier.
One of the things that can be difficult for me to communicate is spendable money. When you put money into the stock market, that is something you can easily turn into cash and spend. Your house can’t be spent. It’s an asset, yes, but you can’t spend your house. You can sell your house to get spendable money. Or you can go re-borrow against your house in the form of a home equity loan, but then you’re back to where you started… with a mortgage payment. And so that’s why I tell people that your house is an asset for your estate to pass along to your children or other heirs. It has nothing to do with retirement for most people. You’re always going to have home expenses, and that’s okay.
Even in Dave Ramsey’s Baby Steps, paying down your house is #6. Investing is #4, and saving for college is #5. Once you’ve met your saving/investing goals completely, THEN you start paying off your mortgage faster with any extra money.
K: So bottom line… buying into the market now should give you even less pause than usual? I mean, everything’s basically on sale, right? And, then, keep your mortgage and keep investing. Don’t change that until you’re exactly where you need to be with saving/investing and you have extra cash?
J: Yes. Anytime the lines are red, it means the prices are cheaper today than yesterday. It’s bad for selling, but it’s great for buying. Keep paying off your mortgage according to your mortgage schedule, and keep investing along the way. Don’t be tempted to forego investing to pay off your mortgage faster. In the end, investing wins.
If you have any questions you'd like us to answer, chances are that others do too... so feel free to email me and I'll ask Jeremy, our resident expert.
Have a great day!
P.S. If you want to look back at our previous post on paying off a mortgage or investing, including the emotional perspective, you can check it out here.