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11 Pay Off the Home Mortgage: Be Ultrafit

I have a good friend who runs a lot of marathons. As you reach Baby Step Six, you reach marathoner status in the wealth-building world. You have run the good race, but you aren’t done.

Bruce, my marathon friend, tells me that at about the eighteen-mile mark, runners begin to lock up. The highly trained and conditioned body starts talking to you about stopping. Big black clouds of doubt enter the mentally tough and trained competitive mind. You begin to think things like, Eighteen miles is pretty good; few others could accomplish that. If you aren’t really careful, “The Good Enough” can become the enemy of “The Best.” “Bad” is seldom the enemy of “The Best,” but mediocrity with a dose of doubt can keep you from excellence. Finishing well can be more important than starting well.

At this point in your Total Money Makeover, you are debt-free except for the house, and you have three to six months of expenses saved for emergencies. You are putting 15 percent of your income into retirement savings and you are investing for your kid’s college education. You are now one of the top 5 to 10 percent of Americans because you have some wealth, have a plan, and are under control. At this point in your Total Money Makeover, you are in grave danger! You are in danger of settling for “The Good Enough.” You are at the eighteen-mile mark of a marathon, and now that it is time to reach for the really big gold ring, the final two Baby Steps could seem out of your reach. Let me assure you that many have been at this point. Some have stopped and regretted it; others have stayed gazelle-intense long enough to finish the race. The latter have looked and seen just one major hurdle left, after which they can walk with pride among the ultra-fit who call themselves financial marathoners. They can count themselves among the elite who have finished The Total Money Makeover.

Baby Step Six: Pay Off Your Home Mortgage

The final hurdle before you turn the corner for the last few miles is to become completely debt-free. No payments. I have said it before, and I will repeat myself until you hear me; if you invested what you pay in monthly payments, you’d be a debt-free millionaire before long. Every dollar in your budget that you can find above living, retirement, and college should be used to make extra payments on your home. Attack that home mortgage with gazelle intensity.

Anytime I speak about paying off mortgages, people give me that special look. They think I’m crazy for two reasons. Most people believe all the mortgage myths. Yes, we must dispel a few more myths. There are two really big “reasons” that keep seemingly intelligent people (like me for years) from paying off mortgages, so we will start with those.

Big Reason Number One:

Myth: It is wise to keep my home mortgage to get the tax deduction.

Truth: Tax deductions are no bargain.

We discussed tax-deduction math when we looked at car fleeces. Let’s review. If you have a home with a payment of around $900, and the interest portion is $830 per month, you have paid around $10,000 in interest that year, which creates a tax deduction. If, instead, you have a debt-free home, you would, in fact, lose the tax deduction, so the myth says to keep your home mortgaged because of tax advantages.

This situation is one more opportunity to discover if your CPA can add. If you do not have a $10,000 tax deduction and you are in a 30 percent bracket, you will have to pay $3,000 in taxes on that $10,000. According to the myth, we should send $10,000 in interest to the bank so we don’t have to send $3,000 in taxes to the IRS. Personally, I think I will live debt-free and not make a $10,000 trade for $3,000. However, any of you who want $3,000 of your taxes paid, just e-mail me and I will personally pay $3,000 of your taxes as soon as your check for $10,000 clears into my bank account. I can add.

Big Reason Number Two:

Myth: It is wise to borrow all I can on my home (or continually refinance for cash out) because of the great interest rates; then I can invest the money.

Truth: You really don’t make anything when the smoke clears.

This one is a little complicated, but if you follow me, you will have intellectually grasped why so many people have fallen into a financial pit. The myth that I was taught in academia is to use lower-interest debt to invest in higher-return investments. Sadly, some “Financial Planners” have told Americans to borrow on their homes at around 8 percent to invest in good growth-stock mutual funds averaging 12 percent because you make an easy 4 percent spread.

Mutual funds are awesome investments, and as I have said, I personally have tons of money invested in good growth-stock mutual funds.

The problem with this myth is that the assumptions used to get to that 4 percent spread or profit on investing are wrong.

Let’s look at borrowing $100,000 on your home to invest. If you borrowed at 8 percent, you would pay $8,000 in interest, and if you invested the $100,000 you borrowed on your home and made 12 percent, you would make $12,000 in return, netting you $4,000. Or would you? Where I live, if you make $12,000 on an investment, you will pay taxes. If you are in a 30 percent bracket, you will pay $3,600 in taxes at ordinary income rates or $2,400 if you invest at capital gains rates. So you will not net $4,000, but instead $400 to $1,600. But we aren’t through yet.

If I own the home next to you and have no debt, and you (because of your investment adviser guy) borrowed $100,000 on your home, who has taken more risk? When the economy moves south, when there is war or rumors of war, when you get sick or have a car wreck or are downsized, you will run into major problems with a $100,000 mortgage that I will never have. So debt causes risk to increase.

Since debt causes increased risk, we must mathematically factor in a reduction in return if we are sophisticated investors. If you can make 12 percent on a mutual fund, and I try to get you to invest in a bet on the roulette wheel, which will return you 500 percent, you would automatically say the two don’t compare. Why? Risk. Common sense tells you not to compare mutual funds and roulette wheel returns without adjusting the returns for risk. Common sense tells you to discount the 500 percent upside of the roulette wheel because of risk. After discounting the roulette wheel for risk, you would rather have the mutual fund. Good choice.

Actually this is done in academia as well. Graduate-level financial people who are taught mathematical formulas to make risky investments compare apples to apples with safer investments after adjustment for risk. We just never apply that formula to a debt-free home versus a mortgaged and invested home, which is very naïve.

The bottom line is that after adjusting for taxes and risk, the debt-free person will actually come out ahead.

Myth: Take out a thirty-year mortgage and promise yourself to pay it like a fifteen-year, so if something goes wrong you have wiggle room.

Truth: Something will go wrong.

One thing I am sure of in my Total Money Makeover: I had to quit telling myself that I had innate discipline and fabulous natural self-control. That is a lie. I have to put systems and programs in place that make me do smart things. A big part of being strong financially is that you know where you are weak and take action to make sure you don’t fall prey to the weakness. And we ALL are weak.

Sick children, bad transmissions, prom dresses, high heat bills, and dog vaccinations come up, and you won’t make the extra payment. Grow up! The FDIC says that 97.3 percent of people don’t systematically pay extra on their mortgage.

Shorter Terms Matter

Purchase Price $250,000

Down Payment $ 25,000

Mortgage Amount $225,000

At 7% Interest Rate

30 Years $1,349 $485,636

15 Years $1,899 $341,762

Difference $550 $143,874

Two hundred fifty dollars more per month, and you will save almost $150,000 and fifteen years of bondage. The really interesting thing I have observed is that fifteen-year mortgages always pay off in fifteen years. If you must take out a mortgage, pretend only fifteen-year mortgages exist.

Myth: It is wise to use the lower rates offered by an ARM mortgage or balloon mortgage if you know you’ll “be moving in a few years anyway.”

Truth: You will be moving when they foreclose.

The Adjustable Rate Mortgage was born, in which your interest rate goes up when the prevailing market interest rates go up. The ARM was born to transfer the risk of higher interest rates to you, the consumer. In the last several years, home mortgage rates have been at a thirty-year low. It is not wise to get something that adjusts when you are at the bottom of rates!

Balloon mortgages are even worse. Balloons pop, and it is always strange to me that the popping sound is so startling. Why don’t we expect it? It is in the very nature of balloons to pop. When your entire mortgage is due in thirty-six or sixty months, you send out engraved invitations for Murphy.

Myth: The home-equity loan is good to have instead of an emergency fund.

Truth: Again, emergencies are precisely when you don’t need debt.

The home-equity loan is one of the most aggressively marketed loans today. The average American in debt to his eyeballs has exhausted all means of borrowing except the big second mortgage on his home. This is very sad because we now put our homes at risk to go on vacation, open a business, consolidate debt, or just for an emergency fund. Families come to us in dire straits when the home-equity loan is their last bad mistake and the straw that breaks the camel’s back.

The banking industry calls these loans HELs for short, and my experience tells me they simply left off an L. These loans are very dangerous, and an unbelievable amount of them end in foreclosure.

Even a conservative person who doesn’t have credit-card debt and pays cash for vacations can make the mistake of the HEL by setting up a loan or a “line of credit” just for emergencies. Most HELs are renewable annually, meaning they requalify you for the loan once a year.

Ed and Sally didn’t realize this. Ed is a very sophisticated financial guy, or so he thought, so he had a HEL for emergencies. Sally had a bad car wreck, and within three months Ed got downsized. They quickly went through the HEL and then got behind in their bills. The annual renewal came up on the HEL, and the bank chose not to renew their loan because of their bad credit, which had been perfect for the previous seventeen years of marriage. The bank called the note. Ed couldn’t believe the bank would kick them when they were down. The note being called meant they had to refinance to pay off the bank, but guess what? They couldn’t because their credit was bad. The end result was very sad; they sold their home to avoid a foreclosure. Ed was wrong. They should have had an emergency fund instead of a loan.

Myth: You can’t pay cash for a home!

Truth: Bet me.

I don’t borrow money—ever. Luke called me from Cleveland to tell me that some of our listeners and readers are doing what Sharon and I have done, “The 100-Percent-Down Plan.” Pay cash. Most people don’t think that can be done. Luke did it.

Luke made really good money. His income at twenty-three years old was $50,000, and he married a young lady making $30,000. His grandfather had preached to him never to borrow money. So Luke and his new bride lived in a very small apartment over a rich lady’s garage. They paid only $250 a month for it. They lived on nothing, did nothing that cost money, and they saved. Man, did they save! Making $80,000 in the household, they saved $50,000 a year for three years and paid cash for a $150,000 home. They closed on the home on Luke’s wife’s twenty-sixth birthday. They lived like no one else, and now they are living like no one else. If you make $80,000 per year and don’t have any payments, you can become very wealthy very quickly. Keep in mind, though, that Luke’s friends and relatives thought he should be committed. They made fun of his cars, his lifestyle, and his dream. Only his bride and his grandfather believed in his dream. Who cares what the broke people think?

Well, there it is, Baby Step Six, debt-free and loving it. Our observation of families who stay gazelle-intense is that they pay off the mortgage about seven years from the date they decided to have a Total Money Makeover. I’m sure by now you are reassured that this is not a get-rich-quick audiobook. What kind of author would tell a microwave culture that it takes an average of seven years to reach the last Baby Step? What kind of author would tell a sound-bite culture that the first two steps take a very tough two or two and a half years? An author who has seen it done tens of thousands of times by ordinary people with extraordinary desire would do that, the same author who tells you it’s not easy, just worth it.

I have used the emotional tag with radio audiences and live audiences that the grass will feel different under your feet when you own it. When you pay off the mortgage, have a barefoot mortgage-burning party and invite all your friends, relatives, and neighbors. Maybe they will catch the bug and want a Total Money Makeover when they see yours is really working.