By any measure, the math says that paying off your home is not a smart move financially. Then why is it that so many people see paying off their home as a great goal?
There are three reasons really. One is out of date thinking, the other is a financial myopia, the last one is No Discipline Syndrome.
Out of Date
Out of date thinking, or as I like to call it “Old Timey Wisdom” (like in Oh Brother Where Are’t Thou – Old Timey Music). Old Timey Wisdom is wisdom that was once true in different times but may not hold up today.
Just one generation ago, paying off your house meant financial security. Often, this was a major deal to this generation, because one generation before a lot of people lost their homes at various times, but most notably during the Great Depression. The wisdom became that as long as your house was paid off, you never had to worry about a huge part of your financial security.
So what is different today than just a few decades ago? Well, then, it was likely that the first house you bought could be the one you lived in your whole life. Of course, there was the concept of a “starter home” which was a cheaper house that you bought first with the idea that you would trade up to your “real” house later after on in life. Even then, it was very likely that you would pay off your house not by doing anything clever, but by simply living there for 30 years until the mortgage ran out.
How likely does that sound today? Between transfers and promotions, layoffs, new opportunities, moving for better schools and so on, the average person will own something like five to seven homes. Do the math. If live in 7 different houses each for just 3 years, that means you will live in six non-permanent houses and it will take you 18 years to do that. If you buy your first house at age 21 then you won’t buy your final house until you are 39 years old. Pay off a 30 year mortgage and you’re 69 years old. That’s great, but it isn’t quite the same as your parents or grandparents might have done.
The other HUGE difference is pensions. Just a generation ago, it was common to work for the same employer for thirty years. At the end of that career you got a pension.
A house isn’t free even if you own it free and clear. There are property taxes, maintenance, insurance, and heating and cooling. With a pension, you had a way to take care of some of these expenses. Without a pension, you have to have some other money to take care of these ongoing expenses. Don’t forget you have to live on that money too. As a professional financial planner I saw a lot of people who didn’t count on that fact and now they don’t know what to do.
With financial myopia you can see something great, but you have a hard time seeing other things. In this case, you can see very well that every month your biggest expense is your mortgage payment. You think that if only you didn’t have that mortgage payment, then things would be different. If I had a nickel for every time I heard this line of thought, I’d have MY house paid off!
While paying off your house isn’t a bad thing, it is important to look around and see the whole financial picture before you make any moves in this area.
First, do you have sufficient savings. Once you send the money into your mortgage company it is gone. You can’t get it back. No matter how much you owe or don’t owe on your house, First National Mortgage isn’t going to mail you a check for $10,000 when your water heater blows out and leaks all over your basement the same week your car starts making a funny sound. That money is what we call “dead equity.” Yes, it is your money, and yes, it helps your net worth, but it can’t be moved to take care of other needs. It is dead to you. I know what you are thinking. You can get a home equity loan.
The home equity loan “rescue plan” has trapped more people than I can count. For starters keep in mind that no matter how much equity you have in your house a home equity loan or a HELOC are still loans. That means you are going to have to qualify for the loan. That means you have to show you can pay the loan back, and the means having a job (or other income) that pays the right amount for the payment.
Too many people lose their jobs (or retire), eat up their savings, and then go into the bank looking for a home equity loan. Sorry. They don’t give loans to people that don’t have a way to pay them back. It takes a lot of work to foreclose on your house and sell it to get their money back. They want to make sure that it isn’t likely they’ll have to do it.
Do yourself a favor and make sure you have built up a sufficient cash reserve BEFORE you start sending extra money to your mortgage.
Remember the whole no-pension thing? Without a pension you have to count on yourself for your retirement income. Here is what I see every day that people have forgot to think about.
If you have a $400,000 mortgage and $400,000 in the bank, you can continue to make your mortgage payments. You can also eat, pay the light bill, and occasionally buy something for yourself.
If you have a $0 mortgage (house completely paid off) and $0 in the bank, you don’t have to make a mortgage payment. Good thing because you don’t have any money. Oh, you also can’t eat, pay the light bill, or buy anything for yourself. Even worse, at least once a year you are going to owe some property taxes. I guess you’ll be selling off your furnishings in order to stay in your house. Again, if you are thinking home equity line here, you are busted. Unless you get it before you retire, no one is going to set one up for you. Even if you do get one are you really getting anywhere? Is it any different to owe $400,000 on a equity loan than to owe $400,000 on the mortgage?
What to do before you pay off mortgage isn’t easy to figure out, but here are some good personal finance tips to start with.