It’s common for people to want to pay off their mortgage early, and for financial advisors to recommend this. I think it’s a bad idea. Here’s why:

You either have the cash to buy a house or you don’t.

If you do: if you invest your cash, a diversified long-term portfolio will return around 6-7% CAGR. You can get a 30-year fixed mortgage at less than 4%, and it’s tax deductible so it’s really less than 3%. Every dollar you pay for the house, is not being invested. So you lose 6-7% in order to save less than 3%. Don’t do that!

If you don’t: you can’t pay cash for a house, so you either rent or buy with a mortgage. If you buy with a mortgage, get a 30-year fixed and don’t pay it off early. Why? Consider the opportunity cost. That is: suppose you have an extra dollar – what should you do with it? Whatever gives you the highest return. Every financial situation is different, but a typical situation greatest benefit first looks something like this:

• If you have credit card debt, you save 18% or more.
• If you invest it, it will earn 6-7%.
• If you put it into the mortgage, you save less than 3%.

Here’s a specific example: suppose you borrow $500k at 3% for 30 years. You decide to pay an extra $100 per month. You’ll pay off the loan about 2 years early saving about $21,000 in interest. If instead you invested $100 every month earning 6% annually, you’d have $100,000. That’s $36,000 in principal and $64,000 in earnings.

By paying off your mortgage early, you gave up $64,000 in order to save $21,000.

Addendum

The astute reader might say, “When you pay off the mortgage 2 years early, you can invest the entire payment over that 2 year period, which increases the value.” So let’s look at this.

The standard mortgage payment is $2,387 and you’ve been adding $100 so your payment is $2,487 per month. If you invest that for 2 years at 6% it earns $63,251. Add this to the $21,000 you saved and you’re at $84,251. This is still less than the $100,000 you would have earned if you invested that $100.