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Friday, 16 June 2017

For the love of mortgages

“Word nerds will notice an eerie root word in ‘mortgage’ — ‘mort,’ or ‘death ... The term comes from Old French, and Latin before that, to literally mean ‘death pledge.'” ref and yet, despite this roughly 70% of Australians are living with a mortgage.ref

In the personal finance sphere destroying debt is a common goal. Bloggers celebrate living debt free, and lament every dollar lost to paying back loans. Every dollar in interest repayments is a dollar out of your pocket.

There's more to it than that though, which is why I'm not actively paying down my mortgage.

The house buying story

In 2014 my father passed away. My brother had moved out of the family home a couple of years earlier, leaving just me and my mother in the family home. A couple of months later in June I scored my first proper adult job, 9 till 5 office work. After a few weeks I learned three things about myself - No way in hell was I working in an office till my 60's, winter makes me cranky and while I love my mother I cannot live with her. At least, not without any other people as a buffer.

While I was reading Early Retirement blogs, I hadn't yet stumbled across the concepts of House Hacking and Rent-vesting. I knew I had the money to buy a house rather than rent so I could bring my pets along, and I knew not to buy outside my means.

Fast-forward three years and I own a comfy, dated 2 bedroom home that desperately needs a renovation eventually. I bought this property entirely in my own name, for $60k less than the banks said I could borrow, and my partner pays 'rent' (which all goes straight to the mortgage), While the decor is horrendously outdated it's nothing that desperately needs fixing. We could DIY some renovations and make the value of the property soar by taking it out of the 80s and into the current decade.

The cost of a house

As it stands, we should be poster children for paying down our mortgage quickly. I bought for less than I could afford without accounting for Mr. FIREs contributions, but here's the tricky part I don't want to waste money paying my mortgage early. (tweet this).

I currently invest $500 - $600 a month while I'm trying to hit my $20,000 cash savings goal. If I threw that money at my mortgages instead I could save $107,000 and knock almost 10 years off the life of the loan. As I've posted before, shortening the life of your loan is a really good thing.

There is something even better though. Something worth continuing my death pledge with the big scary bank. Instead of looking at your debts in horror, look at your net worth. Your net worth is simply the value of your assets (cash, stocks, house, etc.) minus your debts (mortgage, credit cards, those kind of things).

You can grow your net worth in two ways - by having more assets, or less debts.

The cool thing about assets though - once you've set them up they grow themselves! If you have $1,000 invested, next year it's going to be $1,070 (assuming a 7% return). Through compounding it grows even faster each year. Paying down your mortgages is great because you pay less in interest every year, but it doesn't compound in the same way that your investments do (although if you aren't paying your loans compounding will very quickly run against you!)

Maths and graphs

Let's say, hypothetically, that I owe $300,000 on a 4% loan (I actually owe a bit more than this across two properties, but lets keep things simple, the rate is right). Over a 30 year loan it costs $515,610 once you factor in the interest, and assuming that you invest and save nothing else and your property value doesn't change, you end up with a net worth of zero.

How utterly thrilling. After 30 years you are worthless, break out the champagne! Well, you have the equity in your house, but you can't use that to buy champagne, or put food on the table so I've left it out of this argument. In every case your equity would be the same, so to simplify maths lets just ignore it.

Trying another tact, let's throw a bit more money at this mortgage. A 30 year, $300,000 loan needs $1,432.25 a month in repayments, but for a nice round number let's make it $2,000. Your mortgage will be paid off in just under 18 years, and you decide now is a good time to invest. Rather than taking that $2,000 a month and living the high life, you just shift it into a nice safe index fund investment with 7% annual returns. Then your graph looks more like this orange line:

Amazing! After 30 years this time you're worth almost half a million! For an extra $570 a month from day one, you've managed to squirrel away a very tidy sum, in fact your investment portfolio is worth 50% more than you bought your house for!

In scenario one you spent $515,610 over 30 years to be worthless. In scenario two you've output $720,000 on paying your mortgage and investing and now you are worth $488,500. That will definitely buy you a bottle of champagne, and a waterfall to drink it from.

But you can still do better without spending a cent more. Your mortgage is costing you 4% per annum and shares are returning 7%. Each year you aren't investing you are missing out on that 3% difference. So instead, you choose to invest from day one. You make the minimum repayments on your mortgage ($1,432.25) and invest the rest ($567.75). Then your graph looks like this grey line:

See that line surging towards the heavens? That's you with no debt and an investment portfolio worth almost $700,000. In fact your investments are so huge that you can safely drawn down $2,300 every month. You are earning more from your investments than you've been putting towards them. Break out the champagne! After 30 years you own your home completely, no more mortgage, no rent and your investments are huge. Many people have retired on less, pat yourself on the back! If you do your maths properly and don't buy into the retirement income myth, you might just be free from the rat race.

Surely you can't be serious?

So why is this possible? Interest rates. Purely and simply, interest rates on mortgages at the moment are crazy low. I'm paying a mere 4% on my mortgages, whereas the share market has been returning an average 7% a year since we started tracking it. While a 3% difference might not sound like much, after 30 years it makes a massive difference.

Many people hate the idea of paying a mortgage and would never ever go back into debt. Others carry a mortgage while holding massive investments because they know that the returns on their investments will well outstrip the costs of the mortgage.

Me? I love my mortgage. I've been given 30 years to pay back this debt, and my lender isn't hovering over my shoulder demanding the money now, now, now! They know that if I pay it back early they lose out on making money from me. Well I lose out too, on all those years of compound interest.

I could be paying back the banks, or I could be setting aside money for my future self. Which would you prefer?


  1. That is an incredible line of thought. I was so caught up in my idea of 'get rid of house debt now!' that I failed to see the other side of the picture. You paint a convincing picture, I think it's back to the calculators and graphs I go!

    1. I regularly get caught up in paying off my debt, but I have such a flexible mortgage agreement that I can just pull the excess payments out to invest them :D

      I'd love to have no debt, but I'd rather have a huge investment portfolio

  2. Totally agree. Investing is currently way more attractive than paying down debt.
    Investing should take priority. We wouldn't be retired today if we just tried to pay off debt!

    1. Congrats on your retirement! I 100% agree, as long as the debt has a lower rate than the investment - always an important caveat

  3. Hey LadyFIRE, long time FIRE fan, first time reader. I was wondering if you would be willing to divulge whether you're on a fixed or variable interest rate?

    1. Hi Stranger, thanks for commenting :)

      I'll happily divulge that I'm on a variable rate. I have a (very unscientific) theory that if fixed rates are lower than variables, then the economist gurus are expecting rates to keep dropping, so they want you to fix at current rates.

      If fixed rates are higher than variables, then obviously they expect the rates to go up and want to make fixing seem like an unattractive prospect.

      That's my (completed untested) theory on it :)

  4. I agree - to a point. You base your 30 year(instead of paying it down faster) get out of debt strategy on your income being available - what if it's not? What are the chances that you could lose your job? The risk is worth more than the 3% difference to me. I would pay down the mortgage debt. Just my thoughts.

    1. In the event that I lose my job at any point in that 30 year timeline I'll have expenses - whether those are my mortgage, or just basic living.

      If I have my mortgage paid, but no investments, then I have nowhere to go. However on the other hand if I'm $100k in debt, with $100k of investments, then I have time and wiggle room.

      While I hate having debt, I feel much safer having investments and debt, than I would being simply debt free.

  5. An excellent article and a good viewpoint.

    I paid off my mortgage early but only by about 5-10 years. By then I had a good investment portfolio behind me, and the outstanding mortgage amount was not significant compared to my annual salary. The feeling was amazing, but I was happy not having done it earlier.

    1. Hi Erith, thanks for dropping by :) awesome to hear from someone who has done it! I'm only 3 years into my mortgage so while I know it makes sense mathematically, I haven't seen those real world returns yet.

  6. I have been pondering this very issue of late. I have an IO investment loan and after discovering FI/RE I have jacked up my mortgage repayments to cover P&I plus an extra $600 per month on top of that (the $600 is actually my savings). But that money is just sitting there, doing nothing really. So I could actually use those extra repayments/savings to invest instead. Thanks for the article :)

    1. Thank you for reading! And good luck with your FIRE journey.

  7. The interest rates are definitely in your favour! I am curious though, what you would do if the rates rise and it becomes a toss-up between paying down debt vs investing. It does paint a lovely picture if interest rates stay at this level for 30 years, but sadly I don't think that's a reality and we could easily see crazy high rates at some point over the next 30 years.

    Interest rates are a fickle beast over the long-term.

    Mrs DDU

    1. Hi Mrs. DDU, thanks for dropping by.

      I've crunched the numbers and as long as the investment return is higher, it makes sense to invest first. Over 30 years with only a 0.01% advantage to investing you'll come out $2,000 ahead (on a $300k mortgage, with $2,500 of repayments/investments each month)

      While $2k isn't a huge number for the risk what seals it for me is the flexibility. If I have no mortgage and no savings and I lost my job there is nothing I can do - I still need to pay for food and electricity. If I have a mortgage and investments and lose my job I can draw on those investments to get me through until I find another income stream.

    2. That said - if interest rates were 12% and my expected returns were a measly 7% I'd be destroying that debt as quickly as I could!

  8. Have you looked at how you can use debt recycling to achieve a similar outcome?
    I intend on doing this in the new year.

  9. I don't have a mortgage just yet but it is a similar reason as to why I'm not paying off my HECS debt. With the interest on the loan so low compared to the investment returns the math just make sense. Good to see it works out over the long term too.

    I also agree with your other comments about having an investment safety net if you lost your job. Paying off your mortgage makes you asset rich and income poor which unfortunately won't buy you food or pay the bills.

    1. If you were paying off your mortgage and using an offset account (which is pretty standard practice), you wouldn't be asset poor as you could access all that capital in emergency times. Indeed, it is much more fluid than investments and you wouldn't be forced into a situation of having to sell up shares during a down turn in the market that coincides with your emergency and taking an even bigger hit to your capital.

      Furthermore, this strategy is all great while interest rates are at HISTORIC lows. How does it play out when they return to an expected normal of around 6-7% as expected over the next couple years? How does the maths work when you are paying tax at your marginal rate (32%? 49%? plus medicare levy) on those interest gains. For these reasons, I'll stick to dumping as much into my offset account as possible and paying down the principle while interest rates are at such lows.

  10. Interesting argument. Similar to the one I'm having between dumping more into Super vs paying down the home loan. One question I had though was how income tax plays into this. Having capital sitting in an offset account is a guaranteed return of 4%, effectively "tax free". However, every dollar of interest earned on investments is racking up tax at your marginal rate, which will make a massive difference to the grey line on your graphs. If you are in the top income tax bracket, you would be losing half of your interest, pushing you below the effective returns you get by paying down the mortgage.


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