Should You Pay Cash For Your House If You Can?
Pay Off Your Mortgage or Invest?
Dave Ramsey advocates for paying for your house in cash if you can. Other articles will advocate for waiting to pay off your mortgage for as long as you can and use other people's money to pay for your home. So who is right? Well you may not like the answer, but both choices can be right. So what should you do?
The bottom line is when you look at financially independent people, whether they have a mortgage or not, their investments cover their living expenses. So your decision is which choice will get you there faster.
There isn't a silver bullet for all people because it comes down to a lifestyle choice, your risk tolerance, and spending habits. The most important thing to realize is that either option can and will work, there is no wrong answer. No one can say paying off your house is wrong. Warren Buffett, one of the wealthiest men in the world, has never owed anyone significant amounts of money and he seems to have done pretty well for himself.
Other investors such as Robert Kiyosaki doesn't believe in paying of your mortgage and promotes borrowing to buy all real estate. The common thread here is all these investors have made a successful living. How can that be? Because again, there isn't one right answer. But there is a right answer for you. Whichever route you choose, you have to make the correct supporting decisions based on why you chose one option vs the other. So now that we know there is no right or wrong answer, let's consider why you might want to choose one over the other.
Two paths To Success
If you choose to pay off your mortgage, invest what you saved in interest and principal payments after the loan is paid off.
If you choose to have a mortgage, invest the money you would have put towards the mortgage into investments.
These two options sound similar? It's because they are. Either way you have to choose to invest your extra money and how you choose to do that can vary.
The Math Behind Investing vs. Paying Cash For Your House
Let’s say you have 200,000 just laying around to invest either in a mortgage or in stocks. Most people you ask and financial advisors will tell you you'll make more money in stocks than if you pay off your house. That's because on a spreadsheet, they are usually right. It looks something like this. They'll say, you can earn 8% in the stock market vs the 4% or 4.5% you have to pay on your mortgage. Let's look at that scenario.
So you take your 160K (200k minus 40k down payment) and you invest it in the stocks market instead of paying off your house. An 8% return on 160k is $12,800. You may or may not get that return each year but you will likely get that on average over the long run.
In this scenario where you invest the 160K you have to assume you were also paying towards the 160k worth of mortgage that you didn’t pay off and instead invested, so you have to subtract the total interest you paid on the mortgage, or $131,850 in this example.
Though on a spreadsheet you are more wealthy in 30 years, it's important to consider how your life is different without those payments. After all wealth is a tool and a instrument used to give you freedom. Lower cost of living provides increased freedom for 30 years. Not to mention you'll probably end up moving at some point and the interest rate is likely to be higher than todays averages. Ultimately, this is why we decided to pay off the house.
Our Path: We Paid Off the House
Read about our journey to pay cash for our house here. Even if that sometimes means giving up a potential greater future dollar amount that also comes with higher expenses today. I like the opportunity for future cash flow to be allocated towards the next thing I want to invest in. With a lower level of expenses it provides more freedom of choice in how I make money and what risks I can take in my career. It is also how we could afford to have my wife stay at home with our kids and build her photography business.
I do not have any debt and never have. In this way, I have to say I am a Warren Buffett fan. It didn’t take me long to realize that when I looked around me and found the wealthiest people (not those that looked wealthy) don't have debt. They do sometimes have business debt, something I too may have someday, but thats a post for another day. It was more than just a financial decision for me. These are the reasons we chose to avoid a mortgage:
- Life isn't lived on a spreadsheet: Mortgages are really expensive in the beginning - closing costs and loan origination fees, not to mention most people move every 5-7 years. Paying off your mortgage is really just a conservative bond-like investment where you return what you would have spend on interest on your mortgage. This return is realized when the mortgage is paid off. When you have a bunch of money available to spend you tend to spend more, so I liked the idea of putting money in a fairly conservative safe investment like our home that increased our cashflow on a no tax basis, all while reducing debt liability.
- Makes life simple: Eliminating the monthly mortgage removes any worry of how to pay each month.
- Less stress: When you don't have to worry about a monthly mortgage, quite simply, it's less stressful.
- Gives you more flexibility: When you don't have as many expenses, you are closer to financial independence. Assuming a 4% safe withdraw rate, if you only need 6k to pay for your housing every year (property taxes and insurance) vs almost 16k (mortgage plus property taxes and insurance) that's a difference of needing $150,000 vs $400,000 in your nest egg to pay for your living expenses with passive income. So for 30 years you are in a better position to be financially free than if you have a mortgage. That not only feels good, but definitely gives you more options.
The decision to pay for our house in cash was an easy one for us. If math isn't your thing, here is a basic analogy to help explain why we took this route. If financial freedom is a bucket that needs to be filled with water, and each dollar of debt is like a tiny hole in the bucket as you are trying to fill it. Our choice was to avoid a mortgage so we didn't have any holes in our financial freedom bucket. That way, we can fill our bucket much faster!