He has actually done one of the best things that he can do in that situation: eliminate expenses.
When I tried bootstrapping my startup years ago with periodic contract work the albatross around my neck wasn't anything to do with the company, it was the mortgage and other home expenses that continually made it harder and harder to go without a steady income.
People always focus on income without looking at expenses as much, but the closer you can get those expenses to zero the wealthier you really are since you NEED so much less cash flow. It's a huge multiplier.
If I had the ability to pay off all my debt overnight, using my time the way I want to would be a whole lot easier. I absolutely sympathize with the author here. There are several things that I want to build but I have a full time job, a wife and 2 kids. At some point I had to decide that being a good father and husband is more important than pursuing those entrepreneurial dreams. There's only so much time in a day.
I'm lucky in that I have a great job with a company who's mission I fully support and ownership that treats their employees better than any company I've ever seen. It makes it significantly easier to put the company over personal ambitions.
I've always wanted to make $200,000 or so from a successful personal project on the side, just so that I could pay off my mortgage so I didn't have to worry about it anymore.
But when I think about really getting that money, I realize I wouldn't do that. If my mortage is $1200/month, I just bought myself 166 months, or ~14 years. If the idea is to quit your job and invest in a company, that's not the smartest move. You're better off stocking away $72,000 so you don't have to worry about your mortgage in 5 years, and investing the rest in the company (you will not be making money for a while, and on top of paying your own salary, you will need to buy advertising).
If the idea is to avoid the interest on your loan, and be completely emotionally free from that debt, than by all means do it. This would work well if you are just going to do consulting since the cash flow swing isn't as dangerous.
While I agree with you on that point, just looking from a cash flow perspective if you were to keep working for a little while after paying everything off you'd likely be able to save a huge amount of money very quickly. Save, invest, relax on a beach...any of it's easier without that mortgage eating away at you.
I remember when I finally got around to doing the math on my first mortgage and realized I was actually going to pay close to triple the sale price of the house if I waited the full 30 years. The real trick, if you don't want to pay off the whole thing, is to make a lump sum payment to pay down about half of the mortgage early. It's the first 10-15 years on a 30 year where the payments are so interest heavy that you're really just throwing away money.
Get about halfway to payoff as fast as you can though and those payments are a whole lot closer to just paying back a cash balance.
> I was actually going to pay close to triple the sale price of the house if I waited the full 30 years.
Did you adjust for inflation? Even at today's inflation rates, the dollars you pay in 30 years will be worth considerably less than the dollars you pay today. There's also an opportunity cost issue. Paying off your mortgage means not putting the money somewhere else.
> you're really just throwing away money.
No... you're paying for access to a resource that you don't have yourself. There's more utility in that than in literally throwing the money in the garbage.
Matter of perspective I guess. When I looked at my early mortgage payments and 85% of the payment was interest so after 10 years I would have barely paid down the principle at all. To me, that feels like waste.
I invested with steady 12-14% returns for 10 years and then watched it all get wiped out. The interest rate on paying of debt doesn't change. Granted, at current rates it's a lot tougher to make the argument for mortgage interest vs other types of debt.
Nobody ever shows a compound interest chart with anything other than a steady interest rate (aka - 30 years of 10% return = millionaire!). A single negative or downturn can have a pretty dramatic effect on those projections. If you look at those same projection charts and take the amount you'd look to invest over the first 10 years, but put into into debt payment instead of investing so that you get everything paid off, then take that same amount you would have been investing, start investing it plus the money that you're no longer paying in monthly expenses then you'll find the end of the 30 year period to be an almost identical result. The only difference is that after 10 years you've eliminated virtually any risk of personal bankruptcy.
If you can find something with a guaranteed long term return higher than the mortgage interest then it's another ballgame, but those are pretty hard to come by. Right now dividend investing seems to be the closest approach that generally lets you ignore the actual interest rates over time and instead focus on building cash flow.
But this is one of those topics that is part math, part point of view and part personal comfort level. This was just my perspective.
I largely agree with you on this. I focused on my mortgage and as a result I have less than a year of payments left. I didn't ignore investments either - roughly 10% of my income into the market - but I did not pay the minimum mortgage payment in favor of investments.
There was a point a few years ago where liquidating the investments could pay off the mortgage. To me it seems that you can get some of the benefits of the emotional release of being debt free if you have the capability to liquidate and clear debt.
While many people will make the argument that instead I should have paid the minimums and had more money invested with the net effect of reaching the liquidate/pay off point, I agree with the reasoning behind your argument: market volatility will not wipe out debt that has been cleared.
Nobody ever shows a compound interest chart with anything other than a steady interest rate (aka - 30 years of 10% return = millionaire!). A single negative or downturn can have a pretty dramatic effect on those projections.
Exactly. NYTimes had an interesting visualization a few years ago that tracked the S&P 500 to show real-world results. It really shows the effect that doldrum years can have on returns:
To fix the problem of all your payment going to interest, look at a shorter term. A 15 year mortgage is much less popular than a 30 year, but you start seeing a difference in the outstanding principle right away.
You can always get a 30 and pay extra. Why give up that flexibility. In today's market interest rates are so low the difference between the 15 and 30 rate are negligible. Also, ask yourself why the bank wants you to take the 15? It's because they make more money that way. Nit from you directly but they have more money they can loan out the faster you pay it back. Plus they have leverage with the fractional reserve system.
>>I invested with steady 12-14% returns for 10 years and then watched it all get wiped out.
I'm guessing you mean that all your gains got wiped out, not that your investments all went to zero.
On the other hand, a lot of people spent years paying on a mortgage only to get foreclosed on and lose everything including their principal. ie, that investment went to zero, or maybe even negative.
There's a lot to be said for paying down your mortgage, but remember that until you've completely paid off the mortgage all of your equity is at risk.
> if you were to keep working for a little while after paying everything off you'd likely be able to save a huge amount of money very quickly. Save, invest, relax on a beach...any of it's easier without that mortgage eating away at you.
Except the money you spend on your mortgage is year 1 is worth a lot more than the money you spend on it in year 30. Especially with rates where they've been the past several years (our mortgage is 3.25%), cash flow is really the only upside to paying off a mortgage decades early.
> cash flow is really the only upside to paying off a mortgage decades early.
In my limited experience, the freedom of not having a mortgage and a car loan, or any other type of debt, far outweighs the benefits of just cash flow. We now have a sense of freedom we didn't have Before. I think it is going to be very individual how one reacts to it, but for us having a minimal mortgage or none has made a big difference for us. Taking risks, having run startups for the last 20 years, this was a major contribution to being able to do this.
Unfortunately, because of the way monetary policy is structured, it is not possible for all, or even most, to live without debt. Debt is fundamental to our economy. You can only be without it if someone else takes on some amount of debt.
It is interesting that in Sweden, the debt of the population in Sweden has not grown as fast as the assets. Since 1996 when the assets where 2x the dept, the gap has widened. The debt is now nearly 3x the debt. (The last graph in on the page, unfortunately in Swedish). It didn't say anything how this debt and assets are distributed though.
In order for you to pay off your mortgage, you need to receive money. That money was generally created through the creation of debts.
So it is hard to say exactly who took on that debt, but someone probably did.
For more on how debt creates money, read up on http://en.wikipedia.org/wiki/Fractional-reserve_banking. And the person you replied to is exactly right - our entire economic system only works right if there is a lot of debt to go with it.
Even if you have enough cash to pay off a mortgage, if you can invest it with better returns than the mortgage interest rate (not hard these days), then it makes better sense to do that.
While the math doesn't really support paying off your mortgage first, I think for some people is more for the mental peace of mind that you don't have something hanging over your head. I can see why that would be the right choice for some people that are looking for a total change in their life.
General rule of thumb when deciding between eliminating debt or investing is to compare if the debt interest is greater than investment interest (investment rate of return).
If (debt.interest > investment.interest ), pay off debt first. Else, invest.
That's the equation, but you also have to consider risk when you make it, and weigh it against your personal risk tolerance. Paying off a mortgage is like making a risk-free investment for the term of the mortgage with a (pre-tax) return equal to the interest rate. Right now, 10-year T-bills are yielding around 2.4%, most mortgage loans are in the 3-4% range. Your risk tolerance may be higher, in which case by all means put your mortgage principle toward investing in the stock market or your startup, but be aware that a market crash can leave you deep in debt.
If (debt.interest > investment.interest ), pay off debt first. Else, invest.
I disagree with this tremendously. With your strategy, essentially what you are doing is buying stocks on margin. This magnifies your profits if things goes your way and magnifies your losses if things go against you.
Think about it this way - Interactive Brokers is an online brokerage with extremely low margin rates which are often half of current mortgage rates (see https://www.interactivebrokers.com/en/index.php?f=interest&p...). Using your logic, the right thing to do is to leverage yourself to the hilt for every penny Interactive Brokers will loan you at 1.63% or less and cross your fingers you make the right investment choices otherwise you're bankrupt.
Buying investments on margin, no matter how it is done, is extremely risky. You might understand those risks and have a high enough risk tolerance but please don't pretend investing on margin is a general rule everyone should follow.
When they said "investment.interest" I think they meant investment return percentage. I don't think they were advocating for investing on margin and maximizing leverage/risk, but rather deciding whether to put your $ towards your debt or towards an investment.
I don't think they were advocating for investing on margin and maximizing leverage/risk, but rather deciding whether to put your $ towards your debt or towards an investment.
It's the same thing. If it makes sense to keep $300,000 in debt to keep a $300,000 investment then it makes sense to go into $300,000 debt to make a $300,000 investment.
Whether that debt is a mortgage on a primary residence for a tax-equivalent-rate of 2.75% or margin interest for a tax-equivalent-rate of 1.63% makes little difference. This is what people who keep a high mortgage and invest the proceeds of that mortgage don't get. They are doing the equivalent of investing on margin which is extremely high risk. They could lose a large portion (or even all) of their investment and still be left with the debt.
From a google search:
"Buying on margin is borrowing money from a broker to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you'd be able to normally."
That's not what I meant, definitely wouldn't borrow to invest so much as decide to invest (if I came into a new chunk of money) money on hand.
I'm not sure where the assumption is that I meant to invest on margin - it feels like I'm missing something.
The person you're replying to wasn't trying to say you meant to invest on margin but that what you are doing is the same as investing on margin.
When you do margin trading you take on debt to allow you to buy more stock. In your case, you aren't actually "taking on" debt technically, but you choose not to pay it off so that you can buy more stock.
After all, the scenarios break down to debt + more stocks or no debt + less stocks.
Obviously there are some differences, but I hope that explanation of the analogy made sense. The point is, by investing money instead of using it to pay off debt you are increasing your risk and reward whereas when you pay off debt you decrease it.
Sure, if you enjoy pedantry, please go ahead and assume that I mean that's the one golden rule and I'm sitting here blindly buying up mutual funds with every spare dollar I have.
Paying off a mortgage is just like any other investment - you need to look at the terms to see if it's worth doing. It's very illiquid, you can't get your cash back without getting another mortgage. On the other hand, it's a guaranteed rate of return that's probably significantly more than any other guaranteed rate you can find.
If you think you can do better with a different investment then go for it. But remember, someone with a lot more money than you decided that their best bet was to finance your mortgage.
The guaranteed rate of return is a crucial point. (There are admittedly also some tax reasons why not paying off the mortgage early can be relatively beneficial.) However, way too many people look at the overall stock market returns over the past few years and conclude that anyone who pays off their mortgage early is an idiot. By that logic, anyone who could should have taken out a HELOC and bet it on the market.
It would have indeed worked out over the past few years. The conclusion for guaranteed or very low risk investment returns is far less obvious and probably has more to do with liquidity and psychological factors.
The guaranteed rate on your equity is 0%. Got $500,000 in equity? Then that's $500,000 earning 0% interest. Of course you aren't paying mortgage interest but with mortgage rates at 3.5 - 4.25% it's easy to find investments with higher guaranteed returns.
Infinite Banking (using overfunded, dividend paying, whole life insurance) currently has 4.5% guaranteed floors with actual rates with dividends currently at 5.0 - 5.5%. Lots of other benefits as well, life insurance, and being able to borrow money against your policy any time you want for any reason, no questions asked.
Also, a 4% mortgage is only 4% of the whole balance in the beginning. At the end it is 4% of a very small balance. If you use level payments you effectively cut the interest rate in half to make comparison.
Taking out a $10,000 loan at 5% and investing it at 5% results in a profit.
Year 1 - Make a $1000 payment, $9000 balance (5% is $450). Your investment is $10000 at 5% or $500. $9000 loan and $10,500 in investments.
Year 2 - Make a $1000 payment, $8450 balance (5% is $423).
Your investment is $10,500 at 5% $525. $8450 loan and $11,025 in investments.
Your math is wrong. The loan balance isn't reduced by the entire payment, the interest is subtracted first. And it's on the beginning balance, not the end balance. At one time there were progressive payment loans where the balance actually went up the first few years, because the payment didn't cover the entire interest.
Year 1 - Make a $1000 payment, lose $500 interest for a $9500 balance. Your investment yields $500 interest, but you had to withdraw $1000 to make the payment, so you're at $9500.
Year 2 - Make a $1000 payment, lose $475 interest for a $8975 balance. Your investment yields $475 interest, minus the $1000 withdrawal leaves you with $8975.
And so it goes, down to the end. Compound interest works both ways.
Remember what I said above: somebody thought that investing in your mortgage was the best return they could get. Are you willing to bet against them?
You can apply the interest before or after the payment, it doesn't really make that much difference, especially when you pay monthly and it compounds daily. The more often it compounds the less of a difference it makes between interest computed before or after the payment.
It's simpler and more accurate to say that the interest is added to the loan balance and then payments are subtracted. They don't subtract interest from payments, they add it to the balance. Extra payments don't have any interest applied to them, they go straight to principal.
The comparison though is between paying your extra cash flow towards a mortgage or investing it. You don't take money from the investment to pay the mortgage. You pay the minimum to the mortgage and then invest the difference.
As far as why banks want to do loans, you have to understand how banks work. What banks do is different.
Banks take money from deposits and then loan that out. They pay 1% interest on saving account deposits and charge 4% on loans. They are effectively purchasing something at $1 to sell for $4. That's a huge markup (400%). Of course banks want to do loans. They also have fractional reserve working in their favor. They can loan out more money than they actually have in deposits because the money is created out of thin air.
This is the same model used by savvy investors. They make investments using Other People's Money™.
OK, have it your way. Here's a spreadsheet to compare a loan+investment with simply saving the payments. I changed the payment from a nice round $1000 to $1010.24 so that the loan would be paid off in exactly 14 periods. On the left, you see the investment grow while the loan is paid down. On the right, you see an account grow as you add $1010.24 to it each time and collect 5% interest on the balance. They reach the same value at the end.
As for the origin of mortgage money, you're forgetting about the secondary market. Lots of loans originated by banks get bundled up and sold off. That's a very lucrative business for some banks, because they can collect fees for the origination and get their money back right away with no risk.
The "Dave Ramsey" approach of paying down debt rather than investing is appealing to me, and I think a lot of people ignore the extra risk of investing. If I can make 4.5% risk-free paying off a mortgage vs 6% in stocks, I'd pay off the mortgage. But here is another consideration I've never seen discussed before: mortgage interest is static, but investment returns are dynamic. My mortgage interest rate is fixed for 30 years, and that's a long time for the stock market to change. What I mean is, the day I close, my interest rate is probably only a little lower than stock market returns. But surely in 10 or 20 years the stock market will have times at 10% or 15% returns, and I'll still have that low-interest mortgage. It almost seems unfair to the bank! So even though my natural inclination is to pour retirement savings into my mortgage, I wonder if it would be better to keep the leverage of such a low-interest loan so I'll have cash for investing when the market has better returns or lower risk. 30 years is a long time. What do people think?
This might be one reason why interest rates are typically not static in Europe. They have a static interest margin, though. The "weird" thing is that the interest margin is low when the economy is doing well but high when the economy is not doing well (e.g now), but the Euribor rates the inverse of that.
In other words, someone who took a mortgage 4 or 5 years ago are probably now paying close to zero interest, and anyone who takes a new mortgage now has to pay close to 1.5% interest (which is almost completely composed of the margin). And when/if the economy picks up in 3 to 4 years, that person with the 1.5% margin is going to be paying a lot of interest..
It's also very difficult to get a mortgage with a fixed interest at least in Finland. Not unheard of, of course, but the terms are likely pretty bad.
And there will be times when equities will lose value. And you can't reliably time any of this anyway. In general, the best strategy is to diversify and maintain some level of liquidity. By all means, pay down your mortgage principle from time to time (or increase your monthly payment a bit) but probably not to the degree that you have no equity investments and/or very little cash on hand.
Not a fan of Dave Ramsey. He's great if you don't know finance but his advice is geared towards people in the poor and lower middle class brackets that want to stay there. Same with Suze Orman.
Get an overfunded whole life policy and put the extra money into that. Google "Infinite Banking" or "Cash Flow Banking" to understand how it works.
Current guaranteed rates are 4.5% with dividends it comes out to around 5.5% (in the current market, it tends to follow interest rates very closely). That's 4.5% guaranteed for life from companies that have been around longer and still posted profits through the great depression, dot com crash, and 2008 housing crash.
Gains grow tax free and if you take it out as a loan it is tax free as well. Any money you withdraw is tax free up to the amount you have contributed so far.
You can take out a loan for any purpose, for any reason, at any time. If you don't pay back the loan the company could care less because they are getting the interest and it just comes out of the death benefit. Actually, they prefer you don't pay it back because they make more interest. So it really is win/win. Tax free "withdrawal" for you and more interest for them.
Also, it's a loan against, not a loan from. That means you are borrowing money from the insurance company not your money. The entire balance is still compounding.
And, as an added bonus, you are getting permanent life insurance for your family.
Some risks with paying off a mortgage earlier:
1) Equity in a home earns 0% interest. You're money is not compounding. Got $500,000 in equity. Guess what, that $500,000 is earning 0% interest.
2) Your leverage is decreased when you pay off your mortgage. If you have only 20% down (500% leverage) and your home goes up 10% then you just made a 50% gain. If you pay off your loan then your 10% gain becomes a 10% gain.
3) The money you put into your loan could have been earning interest. Yes, you're paying money on the mortgage interest but the mortgage balance is decreasing while the investment balance is increasing.
You can think of it this way. Should you take out a loan at 5% to invest at 5%? The answer is yes, you will come out ahead. The reason is that you are only paying 5% of the whole amount in the beginning. Towards the end you are paying 5% on a very tiny balance. If you pay in level payments then your loan is effectively costing you 2.5% while your investment is getting 5%. It's net positive.
4) Paying down your mortgage means you have more money at risk and less options. If you have some bad luck and default then the bank gets first right to all of your equity. If that equity is stored in a whole life policy it is protected from creditors (may vary from state to state but most are pretty generous). If the bank stands to lose a lot of money they will work with you and give you some flexibility, lower rate, allow you not to make payments for a while, etc. If they can just foreclose then they will do that. The reason a foreclosure is more favorable when you put in more equity is because they can sell it at a lower market rate and still get their money back. If it is underwater and you have very little equity then they would be forced to take a loss from the foreclosure.
5) Your mortgage interest may be tax deductible depending on your circumstance. You are giving that up.
Todd Langford has a really good series of videos that talks about finance and opportunity costs:
Whole life policies are pretty terrible, because they're high-fee and opaque. It's very difficult to compare them like-to-like, and that's on purpose - each insurance company wants to sell a slightly different set of guarantees, risks, benefits and fees. Term life insurance is what you need to protect your family. 401ks, IRAs, then simple index funds are superior investment vehicles.
If you are going to have life insurance until you die, then whole life insurance is cheaper. 95% of term life insurance policies expire and are not renewed. The reason is because term insurance gets extremely expensive as you get older. WL is the same cost every year until you die. Include the cost of term insurance for a person who is 99 years old and term life is extremely expensive. It doesn't make sense to me to have insurance when there is close to 0% chance of you dying and to have no insurance when there is near 100% chance of you dying.
Plus there are the tax and loan benefits of WL. They are inferior with 401k and IRA plans. You can't take out a loan whenever you want. You can only take out a certain amount (usually up to 50%) and only under very strict circumstances. There are maximum contributions with 401k. No so with WL. 401k's are taxed as ordinary income. There are more fees over the longer run with 401ks (2-3% every year vs just high front load with WL). You can't withdraw before 59.5 without penalties (except for 72t). There are strict provisions on when you have to pay the loan back.
With WL you can take out your money whenever you want with no penalties. You can take out loans whenever you want and pay them back whenever you want or just not pay them back at all. Most smart people will just take out loans against their policy and effectively access their money tax free. You can't get that with 401k and IRAs.
That's kind've the point though. Ideally, by the time you're out of the 30 year term for life insurance your investments and assets left to your family will be more than enough to pass on to them. With a 30 year term policy, you can pay $50 / month for 30 years from age 35 to 65 and if something ever happens you'll be able to leave $500,000 for your family. That's a total cost of $18,000 over 30 years for $500,000 in benefits which is an outstanding value.
Taking out loans against whole life policies isn't something I was aware of though. I'd be interested to know what type of rates you could get with the loans against that compared to home equity loans or equity lines of credit that you can also use to get at the money you put into paying off the mortgage if you need it.
I see your points here, but these are trickier than you're making them out to be.
Using the numbers you're putting out here, if you put 20% down on a $500,000 home ($100,000 while borrowing $400,000) there's a couple of discrepancies.
First, paying off the mortgage early. You're right, once it's paid off you will be earning 0% interest. Assuming you don't pay it off early and go with the full 30 year schedule and I'm going to assume a 4% interest rate here, your total payment price will be about $875,000. By paying off early you're eliminating those losses. It's not that you're earning 0%, it's that you're not losing over -100%.
If your home goes up 10%, regardless of whether it's paid off or leverage you actually didn't make anything. You don't make anything on real estate until you sell it to cash out. Until then, any gains in a home that's paid off or mortgaged are identical. The only difference is if you didn't put 20% down and were also paying extra for PMI then the increase in value could get you out of PMI.
Yes, the money on your loan could have been earning interest. Instead it's losing interest so you need to find a guaranteed return higher than your mortgage rate. Guaranteed is the trick there. If you can pull it off with a whole life policy, then great. Without the guarantee market volatility comes into play. If you're a person who is comfortable taking out a loan to invest in something else, your perspective will clearly differ here though.
#4 is admittedly a very good an interesting point that I had not considered at all.
Regarding the mortgage interest being tax deductible, that only gets you back the equivalent you would have paid in income tax. 80% of it is still full interest.
I'll definitely look into the videos and whole life policies though. Anytime I talk about putting money into paying off a mortgage early I always have an equity line open on the house so that I can pull most if it back out for emergencies, including making the actual mortgage payments in the event of a lapse in income for some reason.
With that, available it makes it easier to avoid the foreclosure because you've got a way to use the equity to avoid default and by yourself time. You just have to open the line of credit when you aren't having bad luck.
1) It can tie up cash flow. If you don't make the minimum payments your policy can "eat itself" until it lapses, at which point you lose that money. That being said, there is a large degree of flexibility when designing policies. Set the minimum low and contribute more. Fall back to the minimum when times get hard. If you are further into the policy it can self-fund (basically the dividend payments can cover the premiums and then some). At that point, you don't need to continue any money whatsoever to continue the policy. Most people still contribute money though since it is effectively free interest.
2) It has high load in the beginning. It typically requires 7 years just to break even. The first 3 years you typically will be losing money. It's only designed for long term.
3) You have to be able to qualify for insurance. If you can't you can insure someone you have an interest in parent, child, spouse, sibling, nephew, etc.
You're basically trading a little bit of flexibility with your cash flow in the beginning. If that money is going to be going towards investments anyway though, it really is a good strategy.
Also, you can always take out a loan against in the policy to invest in something else. If you have a decent investment you're actually getting increased leverage.
See this video for how this strategy can be used with real estate investing to get much higher returns:
When I tried bootstrapping my startup years ago with periodic contract work the albatross around my neck wasn't anything to do with the company, it was the mortgage and other home expenses that continually made it harder and harder to go without a steady income.
People always focus on income without looking at expenses as much, but the closer you can get those expenses to zero the wealthier you really are since you NEED so much less cash flow. It's a huge multiplier.
If I had the ability to pay off all my debt overnight, using my time the way I want to would be a whole lot easier. I absolutely sympathize with the author here. There are several things that I want to build but I have a full time job, a wife and 2 kids. At some point I had to decide that being a good father and husband is more important than pursuing those entrepreneurial dreams. There's only so much time in a day.
I'm lucky in that I have a great job with a company who's mission I fully support and ownership that treats their employees better than any company I've ever seen. It makes it significantly easier to put the company over personal ambitions.
Time and a place for everything.