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Should You Pay Off the Mortgage?

Some people hate debt. They hate it with a passion. They don’t like it hanging over their head or weighing them down. They can’t wait to be debt-free.

Many times, those same individuals look to pay down their mortgages as quickly as possible. And they are willing to sacrifice saving for retirement until the mortgage is gone. The logic of this approach is straightforward. Once the debt paid off, future excess income can be plowed into retirement vehicles to catch up on forgone savings during the initial years.

Here’s the question: Is it financially wise to postpone retirement savings to speed up mortgage repayment?

To help untangle that question, let’s meet a set of triplets: Jerry, Kerry, and Terry. They each have a job that offers a 401(k) plan with a 4% company match. They each make $80,000 a year. The triplets are 25 years old, and they each decide to purchase a $180,000 house. Each has saved $36,000 for a down payment. In addition, they each have a budget $1,600 a month to put towards a mortgage payment and/or retirement savings.

Up to this point, Jerry, Kerry, and Terry have followed an identical path. But now they find themselves in a disagreement. They have diverging views on how much of their budgets to allocate towards mortgage payments versus retirement savings. For the first time in their lives, the triplets decide to take separate paths.

Jerry’s goal is to be debt free as quickly as possible. To do this, he spends his entire budget – the full $1,600 – towards his mortgage payment. The bank offers him a 15-year mortgage at 3.50% interest. In less than nine years, Jerry completely pays off his mortgage. From that point on, he allocates the full $1,600 per month into his 401(k) account.

Kerry also wants to pay off his mortgage early, but he doesn’t want to miss out on his potential 401(k) matching contributions. He decides to invest $267 per month into his 401(k) account, which is just enough to get the full 4% match. He uses the remaining $1,333 to pay down his mortgage. Like Jerry, Kerry’s bank offers him a 15-year mortgage at 3.50% interest. Kerry is able to pay off his mortgage in less than 11 years, and from that point on, he allocates the full $1,600 per month into his 401(k) account.

Terry is a saver. He likes the idea of squirreling away as much as possible into his 401(k) account each month. He works with his bank to secure a 30-year mortgage at a 3.75% interest rate, making his monthly mortgage payment $667. Terry devotes the remaining $933 per month into his 401(k) account. After his mortgage is paid off in 30 years, he allocates the full $1,600 per month into his 401(k) account.

Fast forward 40 years. Now at age 65, the triplets are preparing to retire. They each earned a 7% average annual return on their 401(k) accounts. Older and wiser, they reflect on their youthful disagreement. They are curious to know who made the best decision. The most objective way to settle the score, they conclude, is to compare 401(k) account balances.

Here is what they discover.

Jerry, who didn’t save for retirement until his mortgage was paid off, ended up with the smallest 401(k) account balance ($2.3 million). Terry, who saved as much as possible and slowly paid off his mortgage over the longest period, incurring the most mortgage interest in the process, ended up with the largest 401(k) account balance ($3.0 million). Kerry’s approach of just meeting the company match landed him in the middle ($2.7 million).

Here’s the thing. It almost never makes sense to pay down a mortgage as quickly as possible.

In most circumstances, the wisest financial decision is to at least contribute enough into a workplace savings plan to get the full company match. Case in point: Even if mortgage rates are 10% for a 30-year mortgage and 9.5% for a 15-year mortgage – and investment returns remain at 7% for the triplets – saving enough to get the full company match is still more attractive than paying off the mortgage as quickly as possible.

Interest rates must be very high, and investment returns very low, to ever prioritize paying off a mortgage before saving for retirement.

Paying off debt – especially a mortgage – as quickly as possible may yield emotional and psychological benefits, but in most cases, it won’t make you wealthier.

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