Pre-Paying Mortgage and Human Behavior

Earlier this year I published an article that went through our decision to not make extra payments towards our mortgage.

The process we went through to land on that decision was a flip-flop between the different options.

On one hand, we saw the benefits of getting rid of the monthly mortgage payment. But the numbers were hard to ignore, and mathematically it became clear that it was not the smartest move for us. Our timeline meant that we should be able to wait out any bear markets that happen during the time where we build our net worth, and that we should end up ahead if we can stick to the plan.

Even with where we’ve landed, I’m sensitive that not everyone’s situation is the same. And even if someone has a similar situation, they might decide to go with a different path. And that is totally okay with me.

But I think we need to be careful about how we talk about the merits of each option.

The Paying Off Mortgage Early Debate Never Dies

Periodically I’ll see a twitter post or an article that talks about deciding to go with either option. I still enjoy reading these articles, even though it usually ends up being a repeat of what I already know.

Financial Pilgrimage published an article that went through why they decided to pay off their mortgage early. I found it to be a great read, and you should check it out.

One thing that stood out that I wanted to spend time thinking about is the behavioral piece of paying off your mortgage early. It is very common for this point to come up, especially when used as a reason why someone should consider paying off their mortgage early.

Behavioral Perspective of Paying off Your Mortgage Early

The argument, as I understand it, focuses on the reduced stress you get by not having a mortgage payment. Granted, you still have to pay for taxes and insurance, but not having to cover your mortgage payment is a huge amount of money that becomes free every month.

It is also usually brought up that if you don’t pay off your mortgage early, you risk spending that money you “should” be investing.

I’m not trying to totally shoot down this argument, because I do think it has some merit. But like all things with personal finances, there is a give and take depending on multiple factors.

Some Stress Is Good

There is a point where excessively high stress can cause problems. I’m very aware of this issue, as I struggle with high anxiety.

But stress also has a positive side. It requires that we pay attention to what is going on.

A mortgage payment does require that you are able to cover that monthly expense. But that stress can also motivate you to do well in your job. Not having a mortgage payment could make it seem like getting fired or losing your job is not a big deal.

In other words, it could end up wiping out the gains you’ve made paying off your mortgage early. You might not have that mortgage payment anymore, but until your net worth is at a point where you have financial independence, you still need that income.

In the event of a market downturn (or losing your job for any reason), where you lose your job, it does provide some breathing room in having lower monthly expenses. But in both of these scenarios, you will want to try to replace your job so you don’t lose the financial momentum you’ve gained up to that point.

Financial Success Requires Discipline

You work hard to pay off your mortgage early. Bam! You are now experiencing the benefits of those choices. The promised land looks beautiful.

But what is the next phase? Does this mean you should now increase your monthly expenses because you no longer have a mortgage payment?

If you paid off your mortgage early because you were concerned you didn’t have enough discipline to invest that money instead, how will you handle these excess funds once your mortgage is paid off?

What I’m trying to say is the discipline aspect of handling your finances responsibly is always going to be required, regardless of the phase you are in. If you don’t figure it out while you have a mortgage, this problem will transfer to the next phase. Sure, you now have your house paid for, but that doesn’t protect you from wasting the money you were using to pay off your mortgage.

If you were finding an excuse to use the money that you should have been investing, that problem will still be present when you don’t have a mortgage.

Human Behavior Can Be Manipulated

I do think it is true that personal finance is mostly about human behavior.

But deciding to pay off your mortgage early because you don’t trust that you will spend those extra funds only shifts that risk to when you have your mortgage paid off.

If you struggle with dipping into the funds you set aside to invest, it most likely is a problem dealing with one (or more) of the following:

  • Not having a large enough emergency fund
  • Not accounting for the “unexpected” expenses that come up. Things such as car repairs, home repairs, etc.
  • Making it too easy to access your investment funds.

If you have a large chunk of money in a money market account, that is going to be money that is easy to access.

You could set up things to fight your temptation to pull this money out. Maybe you use a system like M1 Finance to auto-invest that money, so that if you did pull out those funds, it triggers a taxable event. If you set up an auto-deposit that puts money into this account, it becomes as automated as a mortgage payment would be.

But I think most of this problem deals with budgeting related issues.

Your emergency fund is meant to be large enough to handle unexpected financial situations. If it can’t handle that task, you should increase it to the level that allows you to roll with the punches.

It also might require setting up accounts or budget categories that allows you to dump a set amount of money every month, that you can use for things such as car repairs, home repairs, and unexpected medical bills. YNAB makes this easy, as the category amounts will transfer month to month and you can easily see how much is in each category.

I do think the behavioral point of this argument is valid, but there are ways to reduce this risk and set things up to make it harder to find a reason to dip into these funds. And part of getting on top of your finances is to learn to how to be disciplined in spending your money in a way that matches your values.

Locking Up Funds In Your House

The idea that paying off your mortgage gives you a guaranteed return (based on your mortgage interest rate) is true.

But by paying off your mortgage early, you don’t have access to those funds unless you:

This means that you lock up these funds in your home. It becomes harder to get access to that money until the home is sold. It is a double-edged sword because you get a guaranteed return on this money, but the money becomes more difficult to pull out.

If you invested that extra money instead, even if the market goes down, you still can access it much more easily. The longer you can wait to touch that money for any reason, the more you increase your chances that it will be more than the equity you gained from paying down your mortgage.

I’ve talked about why I think paying off your mortgage early reduces your options, but I think this is a point worth repeating.

You exchange the guaranteed rate of return by paying off your mortgage early, with being able to access the money more easily and increasing the potential for that money to grow faster.

Don’t Ignore the Elephant in the Room

I’ve acted on impulses regarding our finances in the past.

But I’m learning that unless I get a handle on these toxic behaviors, it will continue to drag us down.

We haven’t started investing in a taxable investment account just yet. But we have started contributing to Roth IRA accounts. This is money that we can pull out our contributions at any point without penalty.

Am I tempted to pull out money from these accounts? Not really.

The main reason for that is we have a healthy emergency fund that has cash we can access if we need to. Even if I was to give in to impulses to waste money on reactive spending, I would probably touch our emergency fund cash first before our investment accounts (which is still a bad idea, but better than touching those other accounts).

Do I have more self-discipline than most people? Probably not, especially if you look at my past behavior. You could argue that our relatively high income helps us not be as tempted to dig into money pots that we shouldn’t touch. But I think having a larger emergency fund does the most in preventing us from touching these accounts.

And above everything else, being hyper-aware of the progress we want to make, makes us not want to touch our emergency fund or investment accounts, and do what we can to keep on track. It isn’t like we always hit our savings goals, or nothing ever comes up. But this singular focus drives most of our financial decisions.

If a person is concerned they are going to spend the money they have set aside to invest, why wouldn’t this also become a problem with their emergency fund? That is cash that can usually be easily accessed.

And that is where I struggle with the behavioral reasons to pay off your mortgage early. It is pretending to solve a problem that it doesn’t end up solving.

Why We Aren’t Paying Off Our Mortgage Early

All of this comes down to a few main points in why we’ve decided to not pay off our mortgage early.

  • We need to continue to be responsible in how we use our money and break our financially toxic behaviors.
  • Based on our timeline, the increased risk of having the potential for increasing our net worth faster is worth it for us.
  • We don’t want to tie up our investing funds into our home at this stage in our lives. We want more options.

You might be at the stage where reducing your monthly expenses soon is the top priority. Or you might already have a large amount of money invested in the stock market and want to balance out your risk profile. These are all great reasons to pay off your mortgage early.

And in ten years, we might decide to pay off our mortgage with one last payment.

I want to close this article with the idea that my intention is not to make anyone feel guilty about whatever they decide. Even if you landed differently than me, you are not making a stupid decision.

Through all of this, I’m learning that I hate credit card debt, but not all debt is equally bad. Businesses go into debt all the time to increase revenue and generate more income. And as much as I hate revolving credit card balances, debt can be a tool if it is used wisely.

The key is that we are intentional with our financial decisions. The more we can set ourselves to have compound interest work in our favor, as opposed to working against us with credit card debt, we increase the chances of landing where we want in the future.

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Steveark
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Mortgage payments should be small enough they have zero impact on your work ethic. However I did find being way past FI did reduce my passion for work. The positive parts of the job meant less and the negative aspects became less tolerable. If someone was house poor and then paid it off early, I think you might be right about it having a negative work impact.