How can you find a secure 5-15% return on your investment with NO risk at all? Simple – start paying off your debts. The FIRE lifestyle begins with paying off the bank, credit cards & mortgage. Debt is a four-letter word that needs to be banished from your financial vocabulary.
There are a few simple strategies to do so. One approach says to pay off the debts you have with the highest interest rates first. These are generally unsecured debts like credit cards and personal loans. Another approach (espoused by Dave Ramsey, the radio host) is to pay off debts starting with your smallest first. That leaves bigger secured loans – like car payments & mortgages – for last. Either can work. The key is attitude. You need to go to war against your debt or you will never live financially independent or have a chance at early retirement.
Some people think that mortgages fall in a special category of debt. Because the interest (for some) is tax deductible, they look at mortgage debt as a low-cost way to borrow money that could then be invested in the stock market or other investments. The problems of this thinking are many. First, mortgage interest isn’t deductible for everyone – only folks that are itemizing deductions (not taking the standard deduction). This also excludes anyone that has an income that puts them above the AMT (alternative minimum tax). All told, less than half of Americans itemize their taxes, according to the Tax Foundation. Second, other investments don’t have the 100% guarantee of return that paying off your mortgage does. The most secure investments (say a bank CD) pay pretty close to 0% today, so adjusting for risk, paying off your mortgage is one of the best relative investment deals you can get.
I have a good friend who disagrees with me. My DW and I paid off our mortgage in 2011 (at 45 years old) and I’ve never looked back. Taking a different view, with interest rates low and the economy on the rebound from the Great Recession, my friend Michael kept his dollars invested in the stock market. Over that period the S&P500 has grown +54%.
It certainly looks like he made the better choice, but did he? The outcome isn’t always the best way to evaluate the strategy. If he successfully bet his ‘mortgage money’ on lucky 13 at the roulette table and doubled it, would you also have thought him a savvy investor? I think not! Risk is risk and while he timed the market very well – no one can know what the future will bring. One needs to compare investments with their best viable alternative. Paying off your mortgage is heads & shoulders above other risk free investments. Don’t believe me? Take out a second mortgage on your house and invest that in the stock market!