The Mathematical Reason for Paying Down a Mortgage Early

For the past few months, there’s a question that I’ve been asking on Twitter that nobody can seem to answer. It’s related to paying down a mortgage early. People often say that paying down a mortgage early is a behavioral decision and not a mathematical one. While I agree with the tremendous benefits of being mortgage-free from a behavioral standpoint, I’m here to argue that there is also a mathematical reason to do it.

There are few topics more hotly debated in personal finance than the age-old mortgage pay-down discussion. One side argues that you should never make extra payments on a mortgage. Instead, those additional funds should be invested in something with a higher return on investment. The other side argues there are behavioral benefits to paying extra on a mortgage. These are the “it will help you sleep better at night” people.

Anyone who has followed my family’s story knows that we decided to pay down our mortgage early in the end. I’d argue that paying off a mortgage early can make complete sense from mathematical and behavioral perspectives. This argument is tough to make in today’s unprecedented twelve-year bull market and historically low interest rates, but I’m going to give it a try anyway. This article does not provide any investment advice, but it shares our story and why we thought paying down the mortgage was the right decision behaviorally and mathematically.

First, A Story

My wife and I decided to improve our finances in 2011. I was approaching the age of 30 with a negative net worth and increasing amounts of debt. We had student loans, car payments, a mortgage and had just spent a bunch of money buying a vacation home with family.

We had two bathrooms leaking into our basement and weren’t sure how to pay for repairs. Credit cards were a possibility. However, we also had a bit of home equity available. So there we were, taking out a home equity loan for about $13,000 (the max we could get) to help with home repairs. At that moment, we knew we had to stop kicking the can down the road and start taking our finances seriously.

We knocked out our student loan debt ($50,000) and car loans ($20,000) in about two years. My wife started a teaching job, and we lived off my income and used her new income to pay down the debt. The next three or four years were a blur. We were met with unexpected home repairs, purchased a couple of new to us vehicles, and in general, found lots of reasons to spend the money we had pegged to either invest or pay down our mortgage.

We were neither investing nor paying down the mortgage early in our case. We were spending the money elsewhere. I believe this is the reality for most people. Unfortunately, not everyone (myself included) has the financial discipline of the personal finance community. Logic does not always prevail. Often, life happens. And life is expensive.

In our situation, we were already putting a good chunk of money into the market and were exploring other lower-risk investments for our money.

The Mathematical Reason for Paying Down a Mortgage

I’ve asked the question below in several venues and can’t seem to get a good answer. Maybe that’s because only a tiny percentage of Americans are in a situation where they have paid off all non-mortgage debt, have an emergency fund, and are already investing a decent amount into the stock market. I get it that we are in a highly fortunate position. If you’re not in this position, I hope this blog inspires you to work towards it.

So for someone that does not want to be an active investor in real estate or a business, where is the best place to put your money if you are looking for a safe, low-risk passive investment?

In the past, many would have invested their money into bonds, Treasury bills, or certificates of deposit. The former rule of thumb was to invest your age into these lower-risk assets. So, for example, if you were 30-years-old, you’d want to be 70% invested in stocks and 30% in bonds or other lower-risk assets.

In today’s market, where can you find a bond, Treasury bill, or certificate of deposit that matches the interest on your mortgage?

Many have gone all-in with stocks without good alternative options out there for passive investing. While I’m a huge advocate for index fund investing, personally, we’ve never felt comfortable being 100% invested in index funds.

While paying down a mortgage technically isn’t an investment, it has essentially replaced the money we would have previously put in bonds or other low-risk assets in our portfolio. As a result, it gives us exposure to another asset class (real estate) while providing a higher return than other alternative non-stock options.

Where Besides Stocks Do You Plan to Invest?

Paying down a mortgage is as close to a guaranteed return you can get today, and I’d argue that it’s the highest return you can get on your money at that low of a risk level. So when someone says they could likely make a higher return investing in the stock market, my answer is that I agree. If you leave that money in stocks for ten years or more, you’ll likely have more money than by paying down a mortgage.

However, not everyone (including myself) feels comfortable investing 100% of their money into stocks, even less volatile index funds. Going all-in on any investment strategy or asset class has more risk than what we are comfortable taking on.

The return you can get on any asset is based on return and risk. Contrary to what others believe, the higher return on stocks is due to the higher risk when investing in the stock market—the lower the risk, the lower the return in most situations. So the risk is part of the mathematical equation that needs to be considered with our investments.

Paying down your mortgage early also doesn’t have to mean shoving all of your money in to pay it down. Paying one extra payment per year, for example, can save you years off the back of your loan. That means if your mortgage is $1,200 annually, adding $100 to each payment can shorten your mortgage by several years.

Why Paying Down the Mortgage Early Made Sense for Us

The mathematical reason for paying down the mortgage is a balance of risk and return and not finding other low-risk assets that have higher returns than most mortgage interest rates. With bonds, Treasury bills, and CDs offering meager returns, paying down the mortgage early has acted as a substitute for these other assets in our portfolio. It also provides exposure to a different asset class (real estate) for someone that doesn’t want to be a landlord.

It’s important to note while we were paying down our mortgage, we never stopped investing in the stock market. Including company matches, close to 20% of our income went into the stock market.

Many people who were 100% invested in stocks before 2008 had their lives destroyed. Being old enough to see that unfold, I never want to be in that situation.

Shoving extra money into the mortgage and paying down other low-interest debt gives us the confidence to continue to put a higher percentage of our income into stocks in the future and potentially even riskier assets such as (gulp) cryptocurrency. Of course, paying down a low-interest rate mortgage may seem restricting at first. Still, a strong financial foundation of being completely debt-free allows us to take more considerable risks in other areas.

Financial Pilgrimage

Mark is the founder of Financial Pilgrimage, a blog dedicated to helping young families pay down debt and live financially free. Mark has a Bachelor’s degree in financial management and a Master’s degree in economics and finance. He is a husband of one and father of two and calls St. Louis, MO, home. He also loves playing in old man baseball leagues, working out, and being anywhere near the water. Mark has been featured in Yahoo! Finance, NerdWallet, and the Plutus Awards Showcase.