Should You Pay Down Your Mortgage?

If you have a fixed-rate mortgage that can’t be easily recast/re-amortized, you should not pay extra on your mortgage. Obviously, this is just my opinion, but I feel very strongly about it. Read on to find out how I almost learned this lesson the hard way.

Should I have a mortgage at all?

First, let me address one question that this post will not answer: should you take on a mortgage at all?

The decision between having a mortgage and owning a home free and clear does not have an easy answer. After accounting for expected investment returns and taxes, the math usually favors keeping a mortgage if the interest rate on the loan is low enough (as prevailing interest rates are at the time of this post). On the other hand, risk and stress-based arguments may favor not having a big mortgage looming over your head. Either direction is fine, especially if you have considered the merits and drawbacks of both options and made a conscious decision. If you’re not sure which was to go, I’m sure you will find many heated arguments from both sides on personal finance blogs’ comment sections.

Of course, in the end, the decision of whether or not to take on a mortgage is often moot because (anecdotally) most people can’t pay cash for their home in the first place.

Assuming I have a mortgage, should I pay it down?

Let’s say you have grudgingly taken on a fixed-rate mortgage to buy your first house (welcome to the American Dream!). In an effort to become debt-free sooner, you might be tempted to make extra payments towards the mortgage principal. My position is that you should not pay extra on your mortgage unless you are literally paying off the entire balance.

The reason for this is simple and it comes down to cash flow.

If you have a $100,000 remaining mortgage balance and an $800 per month payment, you need to cover that $800 every month. That’s what the contract says. If you pay an extra $5,000 towards principal, your new monthly payment is… still $800 dollars. In the United States, fixed-rate mortgages usually do not re-amortize if you pay down principal, so the only benefit you get is that your mortgage will get paid off earlier (likely still in the distant future).

Why does this matter?

Anecdote

To be honest, my original plan with our mortgage was to pay it down aggressively over the course of a few years to become debt-free and greatly improve our monthly cash flow picture. Things were going great and we were on track to hit our target within a few short years.

But then something unexpected happened.

While looking up my MegaCorp employer’s stock price one day, I saw a news article about rumored layoffs. The very next day, I heard from a few coworkers that a strange meeting had shown up on their calendars. Later that morning, I found out that a third of my group had been given the axe. Even strong contributors were let go, presumably in an attempt to trim costs and boost profit. I found it difficult to make eye contact with one of my friends who was on a limited work visa and had just bought an expensive house. How do you broach the subject of someone else’s possible layoff? Especially when a job loss could mean that that person might have to leave the country in as little as two weeks? (Thankfully, my friend did not get laid off that day and he still lives in the area.)

Later that evening, I contemplated what would have happened to me if I’d been laid off. I slowly realized that I didn’t have that much cash on hand because, other than my emergency fund, I’d been throwing every spare dollar at our mortgage. Certainly, we had made great progress in paying it down, but the remaining balance was still high enough that we couldn’t pay it off overnight.

And the worst part is that we were still on the hook for the same payment (a majority of our monthly spending) every month, with or without a job, and with or without a lower remaining mortgage balance.

Paying extra toward your mortgage doesn’t improve your monthly cash flow situation, and that can spell bad news if your income drops dramatically (or disappears entirely).

Job security is an illusion

Sometimes it’s obvious that layoffs are coming. But “sometimes” isn’t crisp enough. The bottom line is that job security often doesn’t exist. You could be a top performer, raking in piles of cash, but impropriety at the top of the company could terminate your job in short order. Or a recession could come along and put your employer out of business, and put you on the street (metaphorically speaking, I hope).

And you’ll still be on the hook for that mortgage payment. Every month.

Pay it off or don’t

In my opinion, if you’ve got a fixed-rate mortgage and you’re wondering what to do about it, it’s a simple binary decision: pay the entire balance off in one fell swoop (and own your home free and clear) or make your normal monthly payments and save or invest the remainder (possibly as a “future mortgage pay-off” fund). There is no middle ground because that calm, grassy middle ground is actually riddled with landmines in the form of unexpected loss of income.

In order words: don’t do what I did and throw extra cash at your mortgage. Keep that money liquid (say, invested in liquid index funds).

A few loose ends

I’m going to wrap this up by addressing a few loose ends and exceptions.

What about refinancing?

Refinancing your mortgage to a lower rate or monthly payment is a fine thing to do, but I personally would not want to have refinancing as my fallback plan. The reason is that, while refinancing is often easy to do in a booming economy while you’re earning money, if you’re in the scenario above and newly jobless, possibly at the start of a recession, your hopes of refinancing are likely not based in reality.

Exceptions

If you have an adjustable-rate mortgage, the preceding discussion likely does not apply because these mortgages usually adjust their monthly payment if you pay down principal. Even some fixed-rate mortgages allow for you to recast your mortgage (recasting means that your monthly payment is recalculated based on the remaining mortgage balance and your original loan schedule). If you’re able to pay down a portion of the mortgage and recast into a lower payment, go ahead. Just make sure you carefully consider your monthly cash flow.

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5 thoughts on “Should You Pay Down Your Mortgage?

  1. Your friend with the work visa only was gambling high stakes when buying a house in a country where s/he had no permanent residential permit. That was the mistake, not job insecurity. Job insecurity is hard enough and should make a person more cautious when making life’s most expensive purchases. First get a permanent residency, then look at buying.

    On a similar critical note, I disagree with your conclusions. What you’ve in fact said is that you don’t have the cash flow to make extra payments on your mortgage. Maybe your mortgage is too high for your income. In fact you’ve said that also, admitting is a large part of your monthly income. It should never be more than 1/3 or you’re buying above your means. You should also never make extra payments if you don’t have enough money saved for life’s emergencies.

    You’ve missed a large point of the effect of paying down your mortgage faster, and that is compound interest on the principal that you’re paying the bank over the course of the mortgage runtime. If that’s significantly less than what you can earn on your savings, then great. But remember that your outstanding amount that you’re paying compound interest on is large and that your savings start small, no matter how promising your mutual fund is that you invest it in. So it’s generally more profitable in the long run to pay back the mortgage than to invest savings. And it’s a guaranteed return (of avoided costs in the interest) whereas investments are fickle.

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    1. Thanks for taking the time to add your perspective and additional relevant considerations!

      As far as buying a home to live in without permanent residency: I agree that it is risky and something I would personally avoid. My intent with that anecdote was originally to communicate the surreal, panicked mood of the day the axe came down unexpectedly.

      As far as cash flow, one quick clarification: I said that the house payment was over half of my monthly spending, not income. Affording the mortgage while employed was never a concern (well below 1/3rd of income). It was only when unemployed (with zero income), that I was concerned (although “zero” income is probably a bit unrealistic thanks to severance, unemployment insurance, and the strong possibility I would find another job quickly).

      Your bring up a great point about not paying extra until you have a sufficient emergency fund. This suggests that my emergency fund, while I considered it fairly robust at the time (about 4 months of expenses) was perhaps not large enough, and that might have prompted my extreme reaction (and continuing aversion) to throwing “extra” money at the mortgage (“extra” in quotes because maybe it wasn’t actually extra and should have gone to the emergency fund).

      Re: compound interest on the mortgage saved and the guaranteed return of paying down a mortgage, the latter was actually the main reason I was paying extra on the mortgage in the first place. Guaranteed returns are very hard to come buy. In my case, the expected return of investments was higher, but the volatility of investments (diversified index funds in my case) and fact that the return isn’t guaranteed do warrant close scrutiny (purely by luck, investments have done great over the intervening time–well over the ~3% I would have save myself paying down the mortgage).

      Thanks again for the thoughtful critique–future readers will appreciate it! I still stand by my decision in my own personal case, but that is likely influenced by a multitude of factors I haven’t even touched on here, so I certainly don’t expect universal consensus because everyone’s situation is different.

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  2. Excellent post and great job highlighting the complexities one needs to consider before paying down a mortgage. I think a lot of folks treat it like credit card debt (you can go up or down no problem) or like a huge pile of $1 mortgages, but the reality is a good bit scarier than that. Scenario testing (e.g., what happens if I lose my job) should be a part of any decision to pay down a mortgage, and there’s a good argument your opinion is spot on.

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  3. At what interest rate would you start to consider paying down a fixed rate mortgage when presented with extra cash flow? At what rate and terms do you think paying extra on an ARM loan makes sense?

    Realistically, you can do the calculations for any scenario and calculate in the risks of either choice, with expected returns, job security, and other economic factors. But, there is an emotional aspect as well to shedding debt from your life.

    Everyone weighs this factor differently. For poor savers, who do not invest extra cash flow into the market, the better decision may be to pay down that fixed rate mortgage. (Hence the phrasing _personal_ finance.)

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