Money Reasons has been inspiring a lot of posts recently. He’s starting to get a bit testy about it too. No more Mr. Nice Reasons. #2 suggested that we use some of this direct opposition (and his fundamental hatred of experts, as indicated in our comments section in this post) to do a few deliberately controversial posts. (You know, like how we used Evan’s
whininess inability to get a joke sensitivity to attract the entire Yakiezie back when we only had 30 regular readers.)
Go ahead and check out his post. We’ll wait.
Anyhow, in this post, he talks about how awesome it is to have finished paying his mortgage (and yes, that is an accomplishment). His mortgage (not including escrow) was 1200/month. Therefore, he says, paying off his mortgage is like having a part-time job that pays 1200/month.
I argue no.
The part of the monthly mortgage payment going to INTEREST is like having a part-time job (so that point stands, and it’s a nice part-time job where you don’t even have to show up). New fresh money that is no longer being thrown away on essentially renting your house from the bank.* For us, that’s about $600/month these days. Not too shabby, but also a bit less than half of what we’re paying on the mortgage (not including escrow which has to be paid anyway).
The part going towards PRINCIPAL is not. The part going to principal is savings. It isn’t new money. It’s money you had targeted for savings and is hopefully now being saved in some other form. (Or heck, if you are hitting your savings happily, then re-purposed in other ways.)
When Money Reasons says that not having mortgage payments is like getting a part-time job that pays 1200/month, that’s like me saying that not funding an IRA is like getting a part-time job that pays $5K/year. In both cases, the money wasn’t evaporating– it was being put towards savings. Not putting it into an IRA doesn’t make me richer! Not putting money into real estate doesn’t create new money like a part-time job would, it just means the old money is finding new purposes.
Debt is negative savings. Paying down debt is savings. To understand that concept, imagine you have 0% interest debt and access to a 0% savings account. You can direct your income into that debt or into the savings account. Whichever you choose, you end up with the same amount of money in the end. (In a real life example you might put the money in low interest savings and pay off the entire debt once the interest rate jumps past the 0%… but you’d rather have the emergency fund while you wait. This would be like subsidized student loan debt in graduate school.) It’s when you add different interest rates (and risk, if you want to get complicated) to the debt and the savings that one or the other may become more attractive.
Cash flow is not the same as income or wealth. You can have a high cash flow and still have no wealth. You can have a low cash flow and be very wealthy. You can increase your cash flow by stopping your retirement saving, not pre-paying your mortgage, and any number of other things. None of these actually increase your income. (Well, technically pre-paying debt increases your income from an economics sense in that you no longer have to pay interest on that, but the *interest* is the new income, not the principal. If you’re pre-paying 0% student debt, for example, that doesn’t change your income at all, just increases your savings.)
But what do I know? I’m just an expert and as we know, experts can’t be trusted. They still think the world is flat. (NB: I don’t.)
Also, cats rule.
Have we explained this concept? Did you enjoy this deliberately controversial post?
*disclaimer: You do get value from renting from the bank– that money is freed up for other things, and there’s discount rates and time preferences and a bunch of complicated stuff. Not saying that renting is throwing money away! It does buy things of value. But in terms of savings, the bank is getting that money, not you.
p.s. Our last MR-inspired post is an editor’s pick in this week’s Carnival of Personal Finance. Sponsored by Fabulously broke in the city.