# How is not paying off mortgage better in normal circumstances?

I have been in USA for 10 years and most people I know have 30 years mortgage which they do not prefer to pay-off even though they have cash hoping to make money in stock market.

Now, say mortgage rate is 5% and s&p 500 returns 9%(which has been a historical average for last 100 years.).At this rate, some one decides to invest the extra cash that they have in stock instead of paying off the mortgage is basically saying I am going to make those (9-5 =4%) in stock market.

That does not make sense considering that when you use that money to pay-off mortgage then you are making a guaranteed return of 5%(by not letting bank make that money from you). When you invest in stock market `instead of paying-off` your mortgage you are only making `4-5%(remember its not 9% its 9-5= 4%)`. Also, that is ONLY IF you make money. Stock market can be volatile(Remember 2008?). Also, you pay 15% long-term capital gain tax on it if you make money on that investment.

OK. so I am from India where people normally buy properties for cash and I have aslo heard rumors about some Chinesse real-estate investors buying american properties for 100% cash.

Which means there are significant number of people in the world who do believe that paying interest to the bank for 30 years may not be best of the ideas.

Why do people choose a may-be 5% as oppose to a guaranteed 5% when they choose to invest instead of paying off mortgage?

• Your `9%-5% = 4%` math is wrong. Your return in the market would still be 9%, so you're choosing between a "maybe" 9% and a "guaranteed" 5%. Actually the choice is a "somewhere between -30% and 40%, but most likely around 9%". Many people are willing to take that risk. Aug 31, 2017 at 20:20
• @DStanley: by `9-5` what I meant was you have to account for money that you are losing by paying 5% to the back every year.
– Lost
Aug 31, 2017 at 20:25
• Your "may-be [sic] 5% as oppose [sic] to a guaranteed 5%" is disingenuous. It's a statistical average of 9% vs guaranteed precisely 5%. And a lot of mortgages taken out over the last several years are more like 2-4%, not 5+. For some concrete numbers, I wrote up a spreadsheet and for a \$100k mortgage at 5% (super high nowadays), investing an extra \$100 / mo puts you over \$31k ahead (investment balance - mortgage balance) by the time you'd have paid off the mortgage putting the same \$100 towards it. Aug 31, 2017 at 21:25
• @TeaLeave You are going to pay your mortgage either way. If you have extra money, you can either earn 9% (on average) by investing it or "earn" 5% by paying down your mortgage (saving on interest). Aug 31, 2017 at 21:34
• If you are accounting for the money you are losing by paying back 5% every year, then your return on paying the mortgage is 5% - 5% = 0%. Aug 31, 2017 at 23:33

The reason is that although the American economy is functioning normally, mortgage rates are stupid-low, and are below a prudent expectation of long-term (30 year) rates of return in the market. I manage endowments, so I say "prudent" in the context of endowment investment, which is the picture of caution and subject to UPMIFA law (the P being prudent).

What's more, there are tax benefits. Yes, you pay 15% long-term capital gains tax on investment income. But your mortgage interest is tax deductible at your "tax bracket" rate of 25, 28 or 33% - this being the tax you would pay on your next dollar of earned income. And in the early years of a mortgage, mortgage payments are nearly 100% interest. So even if it's a wash: you gain \$10k in the market but pay \$10k in mortgage interest -- you pay \$1500 tax on the gains, but the interest deduction redudes tax by \$2800. So you are still \$1300 ahead.

TLDR: the government pays us to do this.

• The American economy is far from functioning normally; we've been in a recession for almost a decade now. Yes, I said that, and I stand by it. If you think there's been a recovery, go to your local mall and see how many shuttered storefronts there are that were places of business 10 years ago. The stock market has recovered, but unless you have a 6-figure portfolio that means very little to you. Unemployment is "officially" down, but half of that is the bottom dropping out of LFRP and the other half is people getting new jobs at ~30% less than they had before. They sure haven't recovered! Sep 1, 2017 at 2:56
• @MasonWheeler "Recession" is a term that has a clear and unambiguous definition -- two or more consecutive quarters of negative GDP growth. And the US economy is not in a recession, and hasn't been since June 2009. It may well be in some other kind of prolonged downturn, but it's not a recession. Sep 1, 2017 at 5:50
• The growth in online shopping far outstrips the decline in old-fashioned retail shopping. That is in fact how economies grow: new companies replace older, less efficient companies. And while it is bad luck for those on the losing side, for the economy as a whole it's better. Sep 1, 2017 at 9:59
• @MasonWheeler: Amazon is just a single online retailer. And it's not just pure internet retailers; most brick&mortar shops now also have online shops as well. Sep 1, 2017 at 14:40
• Just for the record what's relevant to OP is the stock market's behavior, but I totally see Mason Wheeler's point. I didn't until this last election cycle, but now holy smoke, we've got perfectly qualified folks punching way below their weight, holding down 2-3 of the kinds of jobs intended for teenagers and seniors supplementing their social security (and crowding out those people). Skilled opportunity just isn't there. Sep 1, 2017 at 20:14

Lets do the math, using your numbers. We start off with \$100K, a desire to buy a house and invest, and 30 years to do it.

Scenario #1

We buy a house for \$100K mortgage at 5% interest over 30 years. Monthly payment ends up being \$536.82/month. We then take the \$100K we still have and invest it in stocks, earning an average of 9% annually and paying 15% taxes.

Scenario #2 We buy a house for our \$100K cash, and then, every month, we invest the \$536.82 we would have paid for the mortgage. Again, investments make 9% annually long term, and we pay 15% taxes.

How would it look in 30 years?

Scenario #1 Results: 30 years later we would have a paid off house and \$912,895 in investments

Scenario #2 Results: 30 years later we would have a paid off house and \$712,745 in investments

Conclusion: NOT paying off your mortgage early results in an additional \$200,120 in networth after 30 years. That's 28% more. Therefore, not paying off your mortgage is the superior scenario.

Caveats/Notes/Things to consider

• There are tax implications in all direction. There's a lot you can do to avoid/defer taxes on stock investments.
• As you say, stock market returns are variable. However, in the USA at least, over a long period like 30 years there is no time when investing in stocks was a money losing proposition. That includes starting and ending at the worst possible times (sorry, no reference handy). However, that may not be true outside of the US. I was reading a blog post lately (sorry, still no reference link :( ) that was showing that in other countries' stock markets there are long term periods of negative returns.
• Interest rates are low. Really low. People can pretty reasonably get 4%, and some people even lower. That makes the above calculations even more in favor of investing over payoff.
• What people tend to do with their money is emotional, more than rational. However, that emotion is based on prior (and often communal) experience. So for instance, the generation that grew up in the Great Depression saved their money in (government guaranteed) banks and CDs, rather than stocks. In so doing, many of them missed out on the best time to buy stocks. Conversely, the current generation only remembers ever-lowering interest rates and strongly growing stock markets (2000/2001 and 2007-2008 not withstanding). We feel too much what came before, and don't thinking enough about what could happen.

Play with the numbers yourself:

• Also the tax deductibility of mortgage interest. A \$100k house alone will barely get you past the standard deduction, but if you have other things (e.g. your state income tax) or fairly high taxes or insurance, then definitely. At that point the extra deduction (beyond the standard deduction) is reducing your tax by \$25-33 for every \$100 in mortgage ITI paid, putting that amount tax-free in your pocket. Put that in your investments too. Sep 1, 2017 at 20:22

There are several reasons:

• You want to keep a larger portion of your paycheck to spend on other things
• You want to have the option of paying lower monthly payments. You can still prepay and finish the loan in 15-20 years if you want, but you retain the flexibility to scale back if/when times are tough. Yes, the 30-year loan will have a higher interest, but if you're on a tight budget, the safety of a lower payment may be more important.
• You have higher-interest loans, such as student loans, credit cards, etc.
• You want to invest in something that generates a steady (even if modest) dividend stream, and then use that income to accelerate you mortgage payoff. Even after taxes, that passive income will likely eventually compensate for the lost interest on the mortgage. And after the loan is paid off the income stream continues.

In some respects the analysis for this question is similar to comparing a "safe" return on a government bond vs. holding the stock market. Typically, the stock market's expected return will be higher -- i.e., there's a positive equity risk premium -- vs. a government bond (assuming it's held to maturity). There's no guarantee that the stock market will outperform, although the probability of outperformance rises (some analysts argue) the longer the holding period for equities beyond, say, 10 years. That's why there's generally a positive equity risk premium, otherwise no one (or relatively few investors) would hold equities.

One way of looking at it is that your equity in your house is an investment in a particular class of asset, and investing further in that asset class may drive you away from, rather than towards, your preferred asset mix.

It's pretty common here in New Zealand for people's only investments to be their homes and rental properties. I wish those people luck when our current property boom ends.

Certainly there are people who do pay off their homes. Others do not. It's a question of risk tolerance and preference. Some considerations relevant to this question:

Taxes - Interest on a mortgage is tax deductible. Particularly for high earners, this is a significant incentive to maintain a mortgage balance and place extra money in the market instead.

Liquidity - If you lose your job, you can sell stocks to pay the mortgage. But if you have made principle payments on your mortgage but still owe some outstanding balance, you are still required to make monthly payments without any source of income.

Rates - In recent years it is been common to get a mortgage for 3.2% to 3.5%. The difference between those rates and 9% rate of return for the market is substantial.

There are other considerations but the answer in the end is that for many people the risk / reward calculus says the ~5% difference in rate of return is worth the potential risks.

• Liquidity: My last mortgage in the UK allowed overpayments. I could then choose to underpay up to the total of the overpayments - so the liquidity argument was less clear. Of course, that doesn't mean you are wrong. Sep 1, 2017 at 7:48