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I've read a few articles online about investments, and other articles about paying down home mortgages. One thing that I've noticed is that people who advocate paying down mortgages seem to emphasize that it should not be considered an investment.

Until I read those articles, I had been considering it as an investment. I'm not sure why this perspective seems "taboo". Are they just protecting themselves against accusations of bad advice, or is there an actual financial reason that paying down mortgages shouldn't be considered an "investment"?

  • There was a great post on this topic today on The Simple Dollar. – theycallmemorty Aug 13 '10 at 20:23
  • Advisers are not likely to tell you that paying down your mortgage is an investment for the same reason that a barber isn't likely to tell you that you don't need a haircut. – Brad Thomas Nov 3 '16 at 1:43

10 Answers 10

13

I think it is just semantics, but this example demonstrates what they mean by that:

If you put $100 in a CD today, it will grow and you will be able to take out a greater amount plus the original principal at a later time.

If you put $100 extra on your house payment today, you may save some money in the long run, but you won't have an asset that you wouldn't otherwise have at the end of the term that you can draw on without selling the property. But of course, you can't live on the street, so you need another house. So ultimately you can't easily realize the investment.

If you get super technical, you could probably rationalize it as an investment, just like you could call clipping coupons investing, but it all comes down to what your financial goals are. What the advisers are trying to tell you is that you shouldn't consider paying down your mortgage early as an acceptable substitute for socking away some money for retirement or other future expenses.

House payments for a house you live in should be considered expenses, in my opinion. So my view is that paying off a note early is just a way of cutting expenses.

  • My take on it is from the position of already having a budget that includes paying your mortgage. Now you have some spare money and the question is what to do with it. The "return" on paying down the mortgage is something that should be compared with all the other alternatives. If you do pay down the mortgage and don't reclaim the overpayments some way, then the end result will be that you pay it off earlier. The money you would have used on the payments between that point and the originally scheduled end date, is the return on your investment. – GS - Apologise to Monica Aug 6 '10 at 21:55
  • Agreed that it is just semantics btw, but I think it's important to consider it on an equal footing with other things you might do with your spare money. – GS - Apologise to Monica Aug 6 '10 at 21:56
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    Absolutely wrong. Paying early is like getting that same interest rate. – Tim Sep 30 '10 at 18:22
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    @JOhnFx - no - that is not the same thing. Paying down debt is the same as a return at that interest rate. I didn't just reduce expenses. In fact, the expenses remain the same - it is EXACTLY like putting money into a bond at the same interest rate. Exactly the same. – Tim Sep 30 '10 at 19:38
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    equity in the property. Real property is an asset, is it not? – Tim Oct 1 '10 at 14:58
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Paying down your mortgage saves lots of interest. With a long term mortgage you end up paying twice us much to the bank than the sales price of the house. Even low mortgage interests are higher than short term bonds. The saving of those interest are as much an investment as the interest you get from a bond.

However, before paying off a mortgage other higher interest loans should be paid off. Also it should be considered if the mortgage interest create a tax reduction in the comparison with any other options.

6

Your mortgage represents a negative cash flow of $X for N months. The typical mortgage prepayment doesn't reduce your next payment, but does reduce the length of the mortgage. If you look at the amortization table of a 30 year loan, you might see a payment of $1000 but only $50 going to principal. So if on day one you send an extra $51 or so to the bank, you find that in 30 years you just saved that $1000 payment. In effect, it was a long term bond or CD, yielding the post tax rate of the mortgage. Say your loan were 7%. At 7%, money doubles every 10 years or so. 30 years is 3 doubles or 8X. If I were to offer you $1000 and ask for $7500 in 30 years, you might accept it, with an agreement to buy me out if you refinanced. For me, that would be an investment. Just like buying a bond. In fact, there is a real return, as you see the cash flow at the end. The payments 'not made' are your payback.

Those who insist it's not an investment are correct in the strict sense of the word's definition, but pedantic for the fact in practice, the prepayment is a choice to be considered alongside other investment choices. When I have a mortgage, I am the mortgagor, the bank, the mortgagee. Same as a company issuing a bond, the Bank holds my bond and I'm making payments to them. They hold my bond as an investment. There is no question of that. In fact, they package these and sell them as CMOs, groups of mortgages. A pre-payment is me buying back the last coupon on my mortgage. I fail to see the distinction between me 'buying back' $10K in future coupons on my own loan or me investing $10K in someone else's loans.

The real question for me is whether this makes sense when rates are so low. At 4%, I'd say it's a matter of prioritizing any high rate debt and any other investments that might yield more. But even so, it's an investment yielding 4%.

Over the years, I've developed the priorities of where to put new money -

  1. Matched 401(k) deposits
  2. High interest credit cards/ debt
  3. Emergency fund/Roth IRA
  4. Other retirement savings
  5. Other regular savings
  6. Prepay mortgage

The priorities are debatable. I have my opinion, and my reasons to back them up. In general, it's a balance between risk and return. In my opinion, there's something wrong with ignoring a dollar for dollar match on the 401(k) in most circumstances. Others seem to prefer being 100% debt free before saving at all. There's a balance that might be different for each individual.

As I started, the mortgage is a fixed return, with no chance to just get it back if needed. If your cash savings is pretty high, and the choice is a .001% CD or prepay a 4% mortgage, I'd use some funds to pay it down. But not to the point you have no liquid reserves.

5

Let's start from the premise that the mortgage is something you will have anyway because you need it to live (as opposed to say getting a bigger mortgage initially in the expectation of paying it down faster than scheduled).

In that case I think paying down a mortgage certainly is an investment; one with a well-defined interest rate and maturity that depends on the precise terms of the mortgage. For example I have a (UK) mortgage that's fixed for the next two years at about 5%, and allows overpayments of £500 per month, which can be withdrawn at any time. So I treat those overpayments as equivalent to savings with quite a nice interest rate, especially since mortgage interest isn't tax deductible and so I actually get the full benefit of that interest rate.

4

From what I've read, paying down your mortgage -- above and beyond what you'd normally pay -- is indeed an investment but a very poor form of investment.

In other words, you could take that extra money you'd apply towards your mortgage and put it in something that has a much higher rate of return than a house.

As an extreme example, consider: if I took $6k extra I would have paid toward my mortgage in a single year, and bought a nice performing stock, I could see returns of 2x or 3x. Now, that implies I know which stock to pick, etcetera..

I found a "mortgage or investment" calculator which could be of use as well:
http://www.planningtips.com/cgi-bin/prepay_v_invest.pl

(scroll to bottom to see the summary and whether or not prepay or invest wins for the numbers you plugged in)

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    I wouldn't say it's very poor - it is like buying a bond. The difference is the tax advantage of the mortgage and the illiquidity of it. – spacedog Aug 12 '10 at 15:24
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    @spacedog - It's like a very safe bond, since there's no risk of default. And speaking of ultra-safe bonds, a 10-year treasury will earn you 3.8% these days (less tax). Is your mortgage rate (plus tax deductions) higher than that? – user296 Aug 12 '10 at 18:37
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    Would you take money out of a paid-for house and invest it in those same things you mentioned? – Tim Sep 30 '10 at 18:23
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    This rationale is flawed (or described poorly). You're not evaluating the house as an investment. The appreciation of the house is irrelevant. It's a (conservative) investment, because you know exactly what your rate of return will be: the interest rate that your lender is charging you. That may be modified by the tax deductibility of the mortgage interest, but not all people can take that (or might get the same value out of the standard deduction). At the time this answer was written, lots of people had old mortgages at high rates. 2-3x return on stocks is also not typical. – Nate Aug 6 '13 at 21:44
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    This also can illustrate that a penny saved may actually be better than a penny earned. Paying down a mortgage is saving interest payments. An alternative investment will earn you money, assuming it appreciates, but you will also have to pay taxes on the gains. So, not all those earnings are retained. It's the flip side of the mortgage interest deductibility issue. In the end, it depends a lot on each person's tax situation. But, considering that it's basically 100% safe, you'll probably get a better return on paying down a mortgage than alternative safe choices (Treasuries). – Nate Aug 6 '13 at 21:52
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If by "investment" you mean something that pays you money that you can spend, then no.

But if you view "investment" as something that improves your balance sheet / net worth by reducing debt and reducing how much money you're throwing away in interest each month, then the answer is definitely yes, paying down debt is a good investment to improve your overall financial condition.

However, your home mortgage might not be the first place to start looking for pay-downs to save money. Credit cards typically have much higher interest rates than mortgages, so you would save more money by working on eliminating your credit card debt first.

I believe Suze Orman said something like: If you found an investment that paid you 25% interest, would you take it? Of course you would! Paying down high interest debt reduces the amount of interest you have to pay next month. Your same amount of income will be able to go farther, do more because you'll be paying less in interest.

Pay off your credit card debt first (and keep it off), then pay down your mortgage. A few hundred dollars in extra principal paid in the first few years of a 30 year mortgage can remove years of interest payments from the mortgage term. Whether you plan to keep your home for decades or you plan to move in 10 years, having less debt puts you in a stronger financial position.

2

I think there are a few facets to this, namely:

  • Could it be a smart thing to pay off the mortgage early? I would say so, because it (a) frees up cash that you'd otherwise thrown at the interest, no matter how low it appears to be and (b) having no house payment and owning your house outright gives you more options when life happens as you don't have to worry quite as much about losing the roof over your head.
  • It's not got a super return, as the return is essentially the money you saved in not paying the interest, less the potential tax deduction. I tend to ignore the latter because spending, say, $100 to get $25 back doesn't count as an investment return to me.
  • IMHO your primary residence isn't an investment; it's a necessity and looking at it as an investment has got a lot of people into a whole heap of trouble. You can have unrealised gains in your house, but you can't realise them without moving into your car.

Overall, I wouldn't concentrate on paying off the house if I didn't have any other money parked and invested, but I'd still try to get rid of the mortgage ASAP as it'll give you more money that you can invest, too. At the end of the day, if you save out paying $20k in interest, that's almost $20k you can invest. Yes, I realise there's a time component to this as well and you might well get a better return overall if you invested the $20k now that in 5 years' time. But I'd still rather pay off the house.

1

Something you invest in has the ability to grow in value. So examples of investments would be buying stocks, bonds, currencies, commodities. Buying your house or a piece of real estate can be considered an investment because the house/property will hopefully be worth more as time passes. So the act of paying down a mortgage really isn't an investment.

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    What's the difference between deploying $1 in capital to save 5 cents a year on interest on a loan... and deploying $1 in capital to gain 5 cents a year in interest on a bond? They're basically the same (aside from tax treatment). – user296 Aug 13 '10 at 0:30
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It very much comes down to question of semantics and your particular situation.

Some people do not view a house (and most upgrades) as an investment, but rather an expense. I certainly agree that this is probably the case if you pay someone else to make the repairs and upgrades. However, if you are a serious DIYer, that may not be the case. Of course, if the house is a money pit and/or you were unfortunate to buy when prices where ridiculously high, you'll have a hard time making any money on this "investment." To continue this game of semantics, you may also consider the value you extract from your home while you are living in it.

On to the mortgage itself. Chances are that it is a long term, relatively low rate loan and that the interest is deductible. So, there are some disadvantages to paying it down early, even without early payment penalties. Paying down early on the principal is a disadvantage from a tax perspective. How much of a disadvantage hinges on the rate.

Now, a debt is a liability on your personal balance sheet. It drags down any returns you may have from investing. However, a home lone is not generally subject to the cardinal rule of paying off your high interest debt before investing. It should not be relatively high and it pays for something necessary. It may be that any credit card debt you have may have paid for something considered necessary. However, with the relatively high interest rates, you have to question just how necessary any credit card debt really is. Not to mention that there is no tax advantage.

So, it comes down to the fact that a home loan should be relatively low interest, paying for something you must have and that you hopefully have some tax advantage from the interest you pay on it.

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If your mortgage interest is tax-deductible, it's generally a bad idea to pay down the principal on the mortgage because you'd be losing the tax deduction. You could instead invest it in a tax-free municipal bond fund, especially if you're in a high tax bracket (including state and local marginal tax rates). For example, if you have a 5% rate mortgage on your home, you could invest in a 3.5% municipal bond and still come out ahead when you apply the tax deduction to your income at a 44% (33% federal + 7% state + 4% city in NYC) marginal tax rate.

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    That is ludicrous. – Tim Sep 30 '10 at 18:23

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