Why I’m paying off my mortgage before investing

I’ve previously written about how mathematically it doesn’t make sense to pay down your mortgage quickly, but in this post, I will play devil’s advocate and show why we’ve decided to pay off our mortgage before investing.

Time to financial independence

At a high level, it’s because when I crunched the numbers on my quickest path to financial independence, the scenario where I paid off my mortgage before investing was about the same time as the scenario where I paid the mortgage down slowly and invested heavily instead.

The reason the timeline is so comparable is because once you’ve paid off your mortgage you need significantly less passive income from your investments to cover your remaining living expenses.

See the detailed analysis section at the end of this post for a demonstration of this analysis.

Reduced financial risk

While my first objective of the analysis was to find the quickest path to financial independence, the other element is that I’d like reduced financial risk to myself and my family should I lose my job or get sick, especially since we made the decision to go down to one part-time income. This may seem obvious to state but, paying off our mortgage would reduce our minimum expenses by almost 10,000€/year. As our other expenses are already quite low, once the mortgage is paid, we will almost be able to live off one minimum wage job. This reassurance in itself gives us a certain element of financial freedom even before we reach full financial independence.

Guaranteed rate of return

The other thing to consider is rate of return.

A mortgage interest rate will be at least 2-3% for most mortgages in Ireland. Even the newest mortgage provider Avant will only provide 1.95% to very select customers.

Paying down your mortgage is a guaranteed savings of that 2-3%/year.

If that money was in the stock market, you could make 20% in a given year or you could lose 20% in a given year. The average rate of return since inception of the stock market has been 10%. This is PRE tax. If you’re invested in ETFs in Ireland, take off 41% in exit taxes. This leaves 5.9% or 4% after inflation (it’s not that simple as you have compounding and reinvestment of dividends but I’m trying to keep it high level).

In my experience though I have not been so lucky.

I’ve had retirement account investments in Canada since 2013 or so, even in a tax-deferred account (like a pension) I’ve only averaged 3.7%/year or 1.7% if you take out inflation. Though I should say that performance was mostly because I was unaware of the true impact of fees and my provider for most of that time was taking 2.75% of my total investment as their annual fee! Ouch.

In Ireland, I’ve only been investing since May 2019 but so far my initial lump sum is standing at MINUS 4.96%/year after inflation AND I’m still paying taxes on dividends even though I’m at an overall loss since ETFs can’t carry losses forward.

If I’d lumped that money against my mortgage I would have reduced my mortgage payments by almost 100€/month or 1,200/year of post tax money.

Now if I’d started investing at another time where the market performed very well, this could be a very different story but for now this has been my experience and I’m happier focusing our efforts on the mortgage.

Less reliance on market performance in early retirement

The other consideration is for when we reach early retirement. If we still had a mortgage we’d need to withdraw larger amounts from our portfolio to get by. If we no longer have a mortgage, we need to withdraw less from our portfolio and therefore rely less on market performance to fund our lifestyle. This is reassuring as we don’t have to rely on something that’s out of our control to fund a large portion of our living expenses.

Psychological impact of having no mortgage

I recently watched a really interesting interview with Mr. Money Moustache (MMM) and Jesse, the founder of the budgeting software You Need a Budget (YNAB). It’s quite lengthy but has some really great and insightful nuggets in there.

One of which was the topic of paying off your mortgage or not.

MMM said that while mathematically it makes sense to take advantage of lower mortgage interest rates and invest your money in a higher-performing stock market, for him, financial freedom is about building a happy life, not about having the most money. And for him, not having a mortgage makes him feel good and so he doesn’t have a mortgage.

Jesse also made the point that while a lot of people will say “yes it makes more sense to invest than pay down your mortgage”, most people won’t actually invest and so they are neither paying down their mortgage or investing.

The other thing I’d consider here is the psychological willpower it takes to leave money invested in a market that is tanking. While mathematically it makes sense in the long term to invest alongside a low interest mortgage, you need to be really honest with yourself and know that if you saw your portfolio literally halve overnight, would you have the willpower to leave the money invested and allow for it to recover?

You may say so now but until you actually have it happen to you, you will not know how you will react. If you don’t rely on the power of time to recover, and you withdraw your money at a loss then you definitely make a loss AND still have a mortgage to pay off so you are worse off than if you’d put that money against your mortgage from day 1.

Downsides

The only downsides I can think of to this approach are:

We are tying up a lot of our portfolio in an illiquid asset, so if we did fall on hard times, although our expenses would be reduced, we’d also have less access to our money compared to if we had it invested in the stock market. We are reducing this risk by keeping a years worth of living expenses in cash and leaving our existing stocks and ETFs invested as an additional backup.

If the market did outperform our mortgage rate after taxes, we’d potentially have a lower net worth than if we had invested and paid our mortgage off slowly but our main goal is not to have the highest net worth. We are more focused on reducing financial risk and increasing lifestyle options.

As long as we have enough to get by, with a few comforts and even a few luxuries, we are happy. We are also on track to have our mortgage cleared in the next 2-3 years and so that timeframe shouldn’t make a huge impact if we miss out on the market performance during that time.

Detailed analysis

For those of you interested in the analysis comparing time to financial independence by paying off your mortgage first or not. Here it is.

Assumptions:

• 40-year-old married couple with 2 school-aged kids
• Have a mortgage with a few years paid down, 200k remaining
• No other debts and no existing investments
• Earning combined income of 100k (73k after-tax)
• Average of 40k annual expenses (see how our family spent an average of 40k in 2019 and 2020 in Cork)
• Average after tax savings/year = 33k
• Mortgage repayments 1,000/month or 12,000/year
• Mortgage interest rate 2.95% variable (allowing lump sum payments without penalty)
• ETF performance 7.91% after fees and inflation (10% average historical stock market performance, 0.19% fees, 1.9% historical 30-year inflation) – see our ETF portfolio here
• Asset allocation 100% equities/stocks 0% bonds or cash (higher risk and higher volatility but potentially higher rewards)
• Scenario 1: Pay off mortgage as quickly as possible, then invest in ETFs
• Scenario 2: Pay mortgage off slowly and invest in ETFs from day 1

Scenario 1:Pay off mortgage as quickly as possible, then invest in ETFs

Pay existing 12k/year in minimum payments + additional lump sums of 33k/year = 45k/year off 200k mortgage.

Mortgage repayment schedule

Year	Remaining	Min annual payment	Additional payments	Interest	New amount
1	€200,000	12,000	€ 33,000	€5,900	160,900
2	€160,900	12,000	€ 33,000	€4,747	120,646
3	€120,647	12,000	€ 33,000	€3,559	79,205
4	€79,206	12,000	€ 33,000	€2,337	36,542
5	€36,542	12,000	€ 25,620	€1,078	–

ETF investment schedule

Mortgage is paid off in year 5, freeing up 12k in expenses which can be lumped in with the 33k post tax savings for an annual investment of 45k.

Year	Fund	Annual Savings	Gain	Exit tax	Total
1			€ –		€ –
2	€ –		€ –		€ –
3	€ –		€ –		€ –
4	€ –	€ –	€ –		€ –
5	€ –	€ 7,380	€ 584		€ 7,964
6	€ 7,964	€ 45,000	€ 4,189		€ 57,153
7	€ 57,153	€ 45,000	€ 8,080		€ 110,233
8	€ 110,233	€ 45,000	€ 12,279	€ –	€ 167,512
9	€ 167,512	€ 45,000	€ 16,810	€ –	€ 229,322
10	€ 229,322	€ 45,000	€ 21,699	€ –	€ 296,021
11	€ 296,021	€ 45,000	€ 26,975	€ –	€ 367,996
12	€ 367,996	€ 45,000	€ 32,668	€ 239	€ 445,424
13	€ 445,424	€ 45,000	€ 38,793	€ 1,718	€ 527,499
14	€ 527,499	€ 45,000	€ 45,285	€ 3,313	€ 614,471
15	€ 614,471	€ 45,000	€ 52,164	€ 5,034	€ 706,601

Time to FI

Scenario 1 for this couple enables them to reach FI in 15 years (by age 55) starting from 0 investments at age 40. The 706k ETF portfolio allows them to safely withdraw almost 28k/year which is all they need to live as they no longer have the 12k in expenses to pay for their mortgage (40k minus 12k = 28k).

Scenario 2: Pay mortgage off slowly and invest in ETFs from day 1

Mortgage repayment schedule

Year	Remaining	Min annual payment	Additional payment	Interest	New amount
1	€200,000	12,000		€5,900	193,900
2	€193,900	12,000		€5,720	187,620
3	€187,620	12,000		€5,535	181,155
4	€181,155	12,000		€5,344	174,499
5	€174,499	12,000		€5,148	167,647
6	€167,647	12,000		€4,946	160,592
7	€160,592	12,000		€4,737	153,330
8	€153,330	12,000		€4,523	145,853
9	€145,853	12,000		€4,303	138,156
10	€138,156	12,000		€4,076	130,231
11	€130,231	12,000		€3,842	122,073
12	€122,073	12,000		€3,601	113,674
13	€113,674	12,000		€3,353	105,028
14	€105,028	12,000		€3,098	96,126
15	€96,126	12,000		€2,836	86,962
16	€86,962	12,000		€2,565	77,527
17	€77,527	12,000		€2,287	67,814
18	€67,814	12,000		€2,001	57,814
19	€57,814	12,000		€1,706	47,520
20	€47,520	12,000		€1,402	36,922
21	€36,922	12,000		€1,089	26,011
22	€26,011	12,000		€767	14,778
23	€14,778	12,000		€436	3,214
24	€3,214	3,309		€95	–

ETF investment schedule

Year	Fund	Annual Savings	Gain	Exit tax	Total
1		€ 33,000	€ 2,610		€ 35,610
2	€ 35,610	€ 33,000	€ 5,427		€ 74,037
3	€ 74,037	€ 33,000	€ 8,467		€ 115,504
4	€ 115,504	€ 33,000	€ 11,747		€ 160,251
5	€ 160,251	€ 33,000	€ 15,286		€ 208,537
6	€ 208,537	€ 33,000	€ 19,106		€ 260,642
7	€ 260,642	€ 33,000	€ 23,227		€ 316,870
8	€ 316,870	€ 33,000	€ 27,675	€ 1,070	€ 376,474
9	€ 376,474	€ 33,000	€ 32,389	€ 2,225	€ 439,638
10	€ 439,638	€ 33,000	€ 37,386	€ 3,471	€ 506,553
11	€ 506,553	€ 33,000	€ 42,679	€ 4,816	€ 577,415
12	€ 577,415	€ 33,000	€ 48,284	€ 6,267	€ 652,432
13	€ 652,432	€ 33,000	€ 54,218	€ 7,833	€ 731,816
14	€ 731,816	€ 33,000	€ 60,497	€ 9,523	€ 815,790
15	€ 815,790	€ 33,000	€ 67,139	€ 11,347	€ 904,582
16	€ 904,582	€ 33,000	€ 74,163	€ 13,280	€ 998,466

Time to FI

Scenario 2 for this couple enables them to reach FI in just over 16 years (by age 56) starting from 0 investments at age 40. The 1 million ETF portfolio allows them to safely withdraw 40k/year which is what they need to live as they still have 12k/year in mortgage repayments for an additional 8 years.

Once their mortgage is paid off by age 64, they will still have a larger portfolio and could continue to withdraw 40k/year should they choose but takes them a little over a year more than scenario 1.

Want more of this?

I recently did a presentation on something similar where I showed how a 40-year-old couple with 2 kids starting with no investments, earning a combined income of 100k/year, with a savings rate of 50%, could reach financial independence in 13 years regardless of the approach they took.

The scenarios I looked at were:

• paying off the mortgage and then investing in ETFs
• paying the mortgage slowly, maxing their pension and investing the rest in ETFs, and
• paying off the mortgage, then maxing their pension and investing any remainders in ETFs

If you’re interested in how these options weighed up against each other along with the impacts on each portfolio after 30 years of withdrawals, you can purchase tickets to the pre-recorded event for 20€ here. This gets you access to 4 hours of presentations from other Irish, European and US presenter’s perspectives.