Personal finance 101 – paying off your home mortgage

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About Tsh

Tsh is the founder of this blog and lives in Bend, Oregon with her husband and 3 kids. Her latest book is Notes From a Blue Bike, and believes a passport is one of the world's greatest textbooks.

This article is featured in the 153rd Carnival of Personal Finance, hosted by Money and Values.

This is the seventh part in my series on Dave Ramsey’s Baby Steps, a proven personal financial plan. My goal is to explain a really solid money management plan in plain ol’ English, for intelligent yet financially “average” home managers.

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Photo by orvaratli

It’s now time for Baby Step #6 – pay off your house.

Dave Ramsey recommends being debt-free – as in really debt-free. Zero debt – that includes credit cards, student loans, mortgages, the whole bit. This is something most people can’t fathom, because normal in America is having debt. It’s a way of life.

If you’re debt-free except the house (Baby Step #2), you’re free to load up a fully-funded Emergency Fund (Baby Step #3). Once you have that cushion, you can then invest into retirement, an education fund, and in paying off your mortgage. And once you have that paid off, you then have the complete freedom to invest in yourself and not a bank. You can change your family tree.

Here’s the most common argument for not paying off your home early:

  • You get a tax deduction when you have a home mortgage.

Dave’s answer: Let’s say you pay $10,000 in interest one year, which creates that tax deduction. If you didn’t have that deduction, the $10K you kept would be taxed, and if you are in a 30 percent bracket, you would have to pay $3,000 in taxes. In keeping a mortgage around, you are essentially paying $10,000 to the bank to avoid paying $3,000 to the government.

A little side note: Another huge myth in our culture is that you have to own a home, that buying is always better than renting. True, owning a home can be a great thing, but only when you’re financially able to do so. When you buy more than you can afford – and this happens all the time, as we can see from all the sub-prime craziness as of late, that home mortgage becomes a curse and not a blessing.

We are currently renting because we live overseas, and in this particular country, the economy is too unstable to risk taking out a mortgage. But whenever we move back to the States, we plan on not buying a house until we have at least 20 percent saved up. Yes, we want to own a home – believe me, it’s a huge dream of ours. We actually want to build a home ourselves. But it truly does not seem worth it if it means chaining us down with a ridiculous mortgage that doesn’t work. Home ownership is not the answer to all of life’s financial questions. But our culture certainly preaches it these days.

I’m happy to say that I’m not the only financially-aware mom in the blogosphere that’s glad to be renting: Lynnae, Crystal, and the Millionaire Mommy Next Door are all renters, too.

Dave recommends only getting a fixed 15-year loan with 20 percent down and the payment being no more than 25% of your take-home pay. But he even advocates that you can even pay 100% cash for a home. Seriously.

If you had no mortgage, your biggest wealth-building tool – your income – would be completely freed up to really invest it where you want it. Then you get to do some pretty amazing stuff, like build more wealth in order to give like crazy. As Dave says, when you live like no one else, later you get to live like no one else.

We’re almost done with Dave Ramsey’s Baby Steps. We’ve got one more, and it’s an awesome one.

Missed other parts of my series?

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Comments

  1. We are renting now, but in the process of buying a house. We saved every spare penny for a really nice down payment for this house. We also waited and watched to make sure that we were buying what we could afford and also getting a house that was not overinflated in price. I am excited to be finally owning my own home but I am also excited that we did it the right way.

    Awesome Moms last blog post..Random thoughts

  2. Congrats, Awesome Mom! You’re living up to your name. ;)

  3. We’re just starting Dave Ramsey’s Financial Peace University, and so far we’re loving it. I think Dave can go to extremes sometimes with his suggestions, but in doing so I think he really makes people think. When we bought our house (or only debt by the way), we paid over 20% down. Not only did we save on private mortgage insurance, but we had a bunch of equity in the house right away. I think one of our big goals after saving up a nice 6 month cushion is to start making extra payments on the mortgage.

    Petes last blog post..Drive Free Cars and Retire Rich!

  4. @Pete – Yeah, Dave can be a bit extreme, which is why I think he’s polarizing – people either love him or hate him. At least his ideas. Good for you on the huge down payment. I think avoiding PMI is one of the main reasons Dave encourages it.

  5. I don’t use the Dave Ramsey plan, but I do agree with paying off your mortgage. I’m 33 and our mortgage will be paid off in the coming year. We’ll be in this house until retirement – we paid off our starter home before buying this one.

  6. Wow – Congrats, Quincy!

  7. just discovered your blog ~~ love it!

    Jenny :)

    LobotoMEs last blog post..{ i’m so lucky to be YOUR mom samme }

  8. I also just found your blog. Great content and personnal finance 101 guide.

    Kudos!!

  9. We rent too and I love the benefits! I calculated the savings so that I could have some reassurance when everyone else tells me how much money we are “throwing away”. Hopefully soon the market here will change and it will make sense to buy instead of rent, because I do think it would be nice to own a house.

    SmallNotebooks last blog post..Weekend Ritual

  10. We want to own a home someday, but when we buy, we actually want to OWN it. We want to be able to pay off the mortgage one day and we don’t want the payments to be so high that the house owns us.

    Because we’re not there yet, we’re glad to be renting. It frees up a lot of money for us to reach other financial goals before jumping into a house payment.

    Thanks for the link!

  11. @LobotoME & George – Welcome! Glad you like it, and glad to have you here.

    @Rachel/Small Notebook – I’m with you; I truly am looking forward to owning a home. But no, you’re not throwing away money – especially if you’d be scraping by with homeowning.

    @Lynnae – Amen about the home not owning you. And I’m more than happy to link to you. :)

  12. We rent our home and have been in it for the past six years. When we moved in, I thought that it would be fine til I got pregnant, and then when we had our first son I thought it would be ok until we had a second baby. Now we’re on baby number three and I really have no desire to move. Did I mention that we have only 625 square feet to live in? It is possible and for us, it’s perfect.

    Kelly from My Small Centss last blog post..Student Loan Hell

  13. I haven’t checked into this but I do question logic — a bit — on waiting to live later. What if there is no later? There’s something great to be said about having fun now with your family.

    That said, we’re planning to have 20 percent down on our next house, which will hopefully be the place we want to end up.

    Shawns last blog post..A Walk With A View

  14. We only had 5% to put down when we bought our house. We were 24 and 26 at the time, and didn’t have much money to put towards a house. But we got a good loan and found a perfect house, where we plan to stay forever. We’ve been here five and a half years now, and we’re paying off the mortgage as quickly as we can. Our goal is for it to be gone within the next ten years. We’re hoping to beat that number by quite a bit, but overall we’d feel good if we paid off a 30 year loan in 15 years.

    Frugal Babes last blog post..Frugal Blog Network Round Up

  15. I know I’m finding this post a bit late but I had to comment! I haven’t read any of Dave Ramsey’s books but my husband and I had already decided that we would live debt-free and when we said that we meant w/out a mortgage as well! Everyone thinks we are crazy and says that we will never own our own home but we have never been able to find a scriptural reference to debt being a blessing rather than a curse. So, I strongly feel that if the Lord does desire for us to have a home, he will work it out, if not….well, we will just enjoy renting! He has given us contentment no matter what the circumstance and so I know even if we rented our entire life, we would be happy with that!

  16. The problem many people have with Dave Ramsey, isn’t Dave Ramsey! Our modern selves can’t live without cell phones, cable tv, gadgets, games, and weekly dinners out. We are a generations of Gotta Have it NOW!..My parents (in their 70s) had to wait to afford anything, the only “credit” was a bank loan that most folks were afraid of getting into post depression. We are spoiled, overfed, underworked, whiney babies who want everything and want to do little to receive it. Its time to pay the piper and debt is MOST DEFINITLEY NOT normal!

  17. I understand everything Dave is saying right up until the point where he recommends paying off the mortgage early. Then I don’t get it. Yes, people should always buy only as much house as they can afford. But is making extra mortgage payments always a good idea? Arguably the US stock market has had its worst short-term performance in a long time. But the DJIA has still averaged a 7.78 percent return over the last 30 years (Feb 1979 to Feb 2009). If you have a 5% interest rate on a 30 year mortgage, then paying down early likely would not beat the long-term returns of equities. I say likely not because certainly there is some risk here. But risk yields return. No risk/ low risk yields lower returns. If you have 30 years, what is the benefit to paying down early? If you pay down early, you save 3.75% in interest (assuming a 25% marginal tax bracket). If you instead take that money and invest in the market, you have a great chance of making a long term return of close to 8%. If the stock market returns just an average of 3.75% over the next 30 years, we are going to have catastrophic political and social problems to deal with, so the worst case scenario here is really a doomsday scenario.

    Rebecca´s last blog post…Visit to the Park

    • I just wonder what the risk is in being debt-free. Seems like there’s no risk there. And even in a low-risk fund in the stock market with a good-standing track record still has some risk.

      Thanks for sharing your thoughts, Rebecca!

      • Absolutely. Risk tolerance is key. People have different risk preferences, so this rule of ‘minimize mortgage principal’ by definition cannot be a rule. Higher risk simply means a higher variance of potential returns, both good and bad.

        As an economist, I like to say that “risk” is not a four letter word (not one of those anyway). People that take higher risks earn higher expected (and average) returns over the long run. People that don’t make lower average returns. This is a foundational concept of finanial theory. One could take cash and put it in a home safe, which would be the least risky of all. But it would virtually guarantee a negative return over 30 years.

        The fundamental issue here is that people need to be aware of the risk return trade-off and their investment decisions and choose accordingly. A rule of ‘pay down your house as early as possible (or pay 50% down)’ cannot apply to everyone. Millionaire momy next door has a bunch of great links to articles which note that houses are really poor investments in the long run. This adds further support to the idea that if you want to build wealth, you need to think beyond the house. One final point, Dave Ramsey himself advocates investing in equities. So he even recognizes the potentials of diversification and long term wealth building strategies. Individuals just need to recognize their own risk tolerances and decide on wealth creation goals.

        To clarify one point in my earlier post, the 8% return would be 6% after tax (again assuming a 25% tax bracket). That is the right comparison number for the 3.75%. Over 30 years, that interest rate difference of 2.25% would most likely be tremendous in terms of wealth creation.

        This is one issue which cannot be oversimplified.

        • True – he recommends investing in mutual funds. Not single stocks, but mutual funds, which are still equities.

          Thanks for the good discussion, Rebecca. (By the way, just for the record, we are renters, and are in absolutely no hurry to buy a home.) :)

  18. Thank you!

    As Dave Ramsey converts and people who actually enjoy living frugally to allow ourselves to enjoy the fruits of what we DO have AND landlords as well – I couldn’t agree more.

    Obviously I am not unbiased (see: Landlord, I am one, (above) but the idea that you are nothing if you don’t have a mortgage in hand is one of the myths that got so many into this mess.

    There is no shame in renting until you can buy a home. None at all.

    Kymberly´s last blog post…Now showing …

  19. I think Dave Ramsey’s advice is great. So many people waste away their money and don’t even notice it.
    His plan keeps you focused.
    Right now, I am on step 6, trying to pay off my $86,000 mortage by age 30, less than 5 years after I got it.
    And yes, I am also in the stock market.
    It’s a tough challenge, but blogging about it has helped me stay focused!

  20. Thanks for your personal marvelous posting! I certainly enjoyed reading it, you happen to be a great
    author. I will make certain to bookmark your blog and
    will come back sometime soon. I want to encourage
    you continue your great writing, have a nice day!

  21. Excellent read, I just passed this onto a colleague who was doing some research on that.
    And he actually bought me lunch as I found it for him smile Therefore let me rephrase that:
    Thank you for lunch!

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