Kelley wrote recently with the sort of dilemma I get asked about all of the time: Is it better to invest or to prepay a mortgage? We’ve covered this topic in the distant past, but it’s time to review the debate for current readers. First, let’s look at Kelley’s e-mail:
My husband and I are on the right track. At age 25, our only debt lies in our home mortgage. We have the six-month emergency fund in place, I currently meet the 3% 401(k) match offered by my employer, and I started a Roth IRA for myself and my husband last year. I started each Roth IRA with $4,000.
My financial advisor recommended for us to max out each of our Roth IRAs each year. My husband disagrees. He thinks paying off the house is a bigger priority. Starting this year, we’ve made an extra payment on our house each month. If we continue doing this, we can have our house paid off in nine years rather than 30 years. However, we can’t do both.
Currently we’ve decided to throw $1,000 into each Roth each year until the house is paid off. Is this the wise decision? Or is it better to put more toward the Roth IRA and less toward the house?
I understand either option is good because I’m saving money. I’m just curious of which route would be wiser.
Kelley’s right: Both of these options are good. This is like choosing between an apple and an orange. Both taste good, and they’re good for you &madsh; but is one better for you in the long run?
What the experts say
Three years ago, when we last covered this topic (holy cats! — where has the time gone?), I collected the following roundup of advice from personal-finance books:
- Ric Edleman (Ordinary People, Extraordinary Wealth): Never own your home outright. Instead, get a big 30-year mortgage and never pay it off — regardless of your age and income. “Every time you send an extra $100 to your mortgage company, you deny yourself the opportunity to invest that $100 somewhere else.”
- Suze Orman (The Laws of Money): Invest in the known before the unknown. Paying off your mortgage offers a guaranteed return on investment. “You cannot live in a tax return. You cannot live in a stock certificate. You live in your home.”
- Elizabeth Warren (All Your Worth): Save 20% of your income. Use 10% for retirement savings, 5% to accelerate your mortgage, and 5% to save for future dreams. “Paying off your home also does something many financial planners neglect to mention: It gives you freedom. Once that mortgage is gone, just imagine all the freedom in your wallet.”
- Dave Ramsey (The Total Money Makeover): Prepay your mortgage if you can, but only after you’ve saved an emergency fund, and only if you’re putting at least 15% of your income toward retirement. Don’t use a program designed by a broker; use your own self-discipline.
- Dominguez and Robin (Your Money or Your Life): “Pay off your mortgage as quickly as possible.” This book, too, was written when interest rates were higher. Also, the authors emphasize frugality over investing.
Financial authors don’t agree on this subject. Maybe the personal finance gurus writing for the web can clear things up?
- Liz Pulliam Weston at MSN Money: Don’t rush to pay off the mortgage. “You’ve got better things to do with your money, like saving for retirement, building an emergency cushion or even living it up a little.”
- Walter Updegrave at CNN Money: If you’ve funded your retirement, and if it will make you happy, then pay down the mortgage. Otherwise, it makes more sense to invest.
- Laura Rowley at Yahoo! Finance: Using very conservative figures, investing instead of prepaying the mortgage yields an extra $400 per year. If you feel compelled to pay down your mortgage, do it. But realize you’re paying a price to do so. (She offers more details at her blog, as well as tips on how to estimate the investment return you need to earn to make it worthwhile.)
- Bankrate: Pay down your mortgage if your investments would be conservative. Invest if you’re planning to do so for the long term.
- USA Today: It depends on your income, your monthly expenses, your risk tolerance, and your desire to own your home free and clear.
- Kiplinger’s: Invest unless you’re near retirement
- The Dollar Stretcher: Mathematically, it makes more sense to invest, but it all depends on your risk tolerance.
- My fellow pfbloggers at Bargaineering and Million Dollar Journey recommend that a person do a little of both: pay down the mortgage some and invest some. Free Money Finance says: “If you have the discipline to save/invest the money you would be using to pay off the mortgage, it’s likely that saving/investing is the better option. But if you’re more the “average” person out there managing your money, I still believe it’s a better option to pre-pay your mortgage.”
The Rowley article offers some interesting background to this debate:
Why do so many people choose to put extra money into a mortgage when other options would likely increase their wealth? “This is really remnant of Depression mentality that has persisted from generation to generation,” says [one expert]. At the time, most mortgages had one- to five-year terms, with a lump sum payment due at the end.
“Any shock to income meant you couldn’t afford your payment — mortgages were much more susceptible to economic uncertainty,” [the expert says], and roughly one-quarter of Americans were unemployed during the Great Depression. “It’s fine to pay down your mortgage if it gives you peace of mind, but you should recognize what that peace of mind costs.”
If you’re facing a similar decision, you may find this calculator useful: prepaying your mortgage vs. investing.
The bottom line
My conclusion in 2007 (and the one I still hold today) is that unless your mortgage rate is very high, it makes more sense mathematically to invest your money. But most gurus agree that psychologically, you should do what works for you. If paying off your mortgage would take a weight off your shoulders, then pay off your mortgage. Sure, you might be losing a bit in the long-term, but you’re still making a smart choice. As I said earlier, it’s like choosing between an apple and an orange. One may be better for you, but they’re both good.
Ultimately, I kind of like the choice that Kelley and her husband have made. They’re prepaying their mortgage and putting some toward retirement. But enough of what I think. Kelley really wants to know what you think.
Which option is better? Should she and her husband be pumping as much as possible into their Roth IRAs? Or should they be paying down their mortgage as quickly as they can? Have you been faced with a similar dilemma in the past? What did you choose to do? And would you make the same choice again?
I am a 24 year old male law graduate, and I am currently chambering (i.e. doing legal training) in a law firm. At the same time, I am just beginning (the equivalent of) a recognized Masters degree in Islamic banking and finance, which would end in about 1.5 years, or 2+ years the industry training. By the time I end my postgraduate studies, I would be 25 or so.
I have no idea where life will take me, but I hope to be able to work overseas or in an international bank — though I am sure that my postgraduate degree, being fully accredited and backed by my country's central bank, will be very helpful. To whatever extent that I can, I would prefer not to practice law, as my father is a lawyer, and I grew up fully appreciating the difficulties of being a practicing lawyer. (i.e. Being a lawyer is my backup plan; if all other plans do not work, I will still be professionally qualified to practice as a lawyer, and I did fairly well so to become a lawyer would not be a problem.)
Regarding my finances: I have no personal liabilities, other than an old loan for a engineering degree which if converted to US dollars amounts to approximately $30,000. (The engineering degree didn't happen, as though I did very well in school and in the sciences, I became disenchanted with engineering when I entered university, and switched to law after my first year mostly because of the flexibility of a law degree). I am blessed as my father could afford to pay for me through university. However, regarding the study loan, I have seeded an investment account with some small capital, and its monthly dividend is enough to automatically pay off the loan's monthly installment until all of it is paid, so the loan is not too worrisome a matter.
I do not have a car, or a house, nor do I plan to get either for now. (The car, maybe in one or two years, but the house, definitely much later.) I have only one bank account, in which there is currently nothing. My siblings and I are currently living with our parents (in my culture, it's considered rude to depart from home, for both males and females, unless you marry or must work in some faraway place) so at least I do not have to worry about rent, bills, car fuel, etc. I also have no plans to marry or have children anytime soon, because I'm prioritizing my career and financial stability first.
As for income: I am currently receiving an allowance from the law firm, which though not a very handsome sum, is more than enough for me, as I do not spend much. (More on my spending habits below.)
My spending habits: I am not so frugal, but I'm not a spendthrift either. I splurge only on the occasional coffee and big meals with friends, but other than that I don't spend much money elsewhere. When I was younger, I used to love gadgets — e.g. PDAs, phones, iPods, game consoles, etc — but having grown up a bit I realized that these things usually bring me no joy after the first few months fade away, so these days I make calculated spending decisions and buy only those things that I know I will last and enjoy repeated use from. (E.g. guitars, non-branded clothes, etc. MetaFilter's financial advice really helped me out — I learned how to save by thinking of a purchases as a matter of cost versus hourly income, and the "$1 per use" value of an item, etc.)
About me: I enjoy the occasional movie, but I don't watch TV. (I haven't sat on the TV sofa for several years.) But I love books, and I read a lot of non-fiction. In my spare time, I also study languages, partly out of passion, and partly because I'd like to use it for work. (I can read Japanese well, and I already qualify for JLPT1, but I will take the test sometime later as I don't have the time. Who knows, maybe with it I can get finance work in Japan?) I've done programming work before, and though I'm no John Carmack, I'm quite alright. I am satisfied with all I personally have at this point (my guitars, my effects pedal, my computer) and there is really nothing else I want.
I am not hungry for money. So when I actually start working, I wouldn't mind starting off with a medium-sized pay, but I'd love to be able to maximize what I can do with that money through investments, savings, or asset acquisitions as soon as I can, and then, as the years fly by, do bigger things with my increased pay.
i.e. I would love to start off life intelligently, and I would like the smart people of MetaFilter to help me out. I'd be pleased to receive any kind of advice — e.g. arguments like "a house is not an asset" , books to read, possible related job opportunities, investment methods, assets to buy, what bank products to look out for or how to employ my bank account properly, ways to steer my life professionally, etc. Anything goes. I am here to learn, and I will lend an ear to all advice. If I must buy books or do things to read, then I will go out and buy those books and do whatever else I have to do. (But I am not that smart financially, so if your advice is very technical advice, I will try my best to understand but I would also appreciate simple analogies to start off with.)
To sum it up: "If you could start off your life from my position, how would you do it, both professionally and financially?"
I'm also available for followup at .
[Note to Metafilter mods: I'm posting this anonymously, because I'd rather prefer not to attach information regarding my personal life/finances/professional career to my username. If this question is approved, please delete this paragraph.]
Mike Fuljenz
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