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.
Is it?
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).
HOWEVER,
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.
Grumpy Rumblings (of the formerly untenured) 
March 7, 2011 at 2:14 am
Interesting spin on the article, but I don’t think it’s controversial.
I’ll debate one point though. If you change your phrase to be “paying down non-consumer debt is like savings” then I wholeheartedly agree. A lot of consumer debt is stuff you spend money on that does not have a value at the end, like vacations, going out to eat, paying other bills, buying groceries, etc.
Even if you buy furniture, cars or clothes with consumer debt, the value of those items depreciates significantly over time. Unlike housing, you can’t just go resell stuff and get close to what you bought it for.
March 7, 2011 at 6:08 am
It’s still a liability that you have to pay, even if the bank takes away your car, for example. It’s still a red line on the balance sheet– you still have to pay the amount you owe.
Appreciation/depreciation is something separate. The house will appreciate whether you pay down your mortgage or not.
March 7, 2011 at 3:31 am
nicoleandmaggie: I was very interested in your article since I recently paid off my mortgage. I understand and agree with all that you said, thanks.
However, I just wanted to say that it sure feels good knowing the house is all mine now.
March 7, 2011 at 6:05 am
I disagree…I believe that the sooner you can pay off your house, the better you are in the long run. Just because you can afford to pay your mortgage now, who says that in 5 years or so that you will still have a job? Who pays the mortagage payment then? Pay it off while you can…while you still have a job. Then, if something happens, at least you’ll have a roof over your head. Once that house gets paid off, then discipline yourself to take the money that used to go toward the mortgage and put it into some type of savings account. Not only will you have a paid-off house, but you’ll also be building up your savings. Now THAT makes sense to me!
March 7, 2011 at 6:07 am
I think you’re arguing a different point than the one we’re making.
We’re saying that the part going to interest is new money. The part going to principal is a form of savings.
March 7, 2011 at 6:28 am
In hindsight (being 20/20 of course) I’m kicking myself that I’ve upped my mortgage payments as much as I did and not put it into the market. Paid an average of 3% on the mortgage (aka second job) last year and made over 25% on investments. It makes me cringe.
But having read The Paradox of Choice, I’m okay with it. Sorta.
Oh, here’s a good comprehensive summary of the book so that people can optimize their reading time. Cuz books R hard. And so long.
http://sivers.org/book/ParadoxOfChoice
March 7, 2011 at 6:36 am
Paradox of choice is awesome.
And it’s diversification! I have no regrets.
March 7, 2011 at 8:45 pm
If I don’t regret, how will I know to do better next time?
Oh, and dogs and cats are equal in my heart. And sometimes the face and the feet.
To Money Reasons point on flexibility, I have great flexibility in knowing that I made enough in ze stocks to pay my mortgage 4 times over and interest for loads of years. No real flexibility, since I’m not doing anything different and just saving it anyway. I do like the concept of forced savings in a mortgage though, especially for younger people. You don’t even notice that you’re saving as much as you are it seems when you’re hacking away at that sucker. I know when I didn’t have a mortgage before, it gave me a lot of peace of mind. Not enough that I thought I was earning passive income though.
March 7, 2011 at 8:49 pm
Well… if next time you have an accurate crystal ball…
But most of us can’t predict the stock market so we’re best diversifying. So long as you used a reasonable investment strategy, there should be no regrets.
March 8, 2011 at 8:09 pm
Ha, my hindsight shows the exact opposite. If I’d been upping my mortgage payments instead of putting so much into the market, my mortgage would have been paid off by the plummet, and I could have put more money into stocks during the (cheap!) plummeting times! Oh well, one more year and I’m done anyway.
March 8, 2011 at 8:12 pm
Yay for being done soon!
But it sure would be nice to have an accurate crystal ball.
March 7, 2011 at 8:01 am
You are wrong about one thing, it is dogs that rule. (Even though I own no pets.)
Interesting thought on interest versus principal. So if MR is blowing the 1200 every month on food and fun, then he is actually worse off than he was before, because he had implied savings via the equity he was building in his house. Hmm. (Not saying he is doing that, just an example.) However, if MRs house plummeted in value, he was ‘losing’ money and not saving…
March 7, 2011 at 8:19 am
Exactly! Blowing the amount of interest he was paying would be the same as before.
Unless he defaults, he still has to pay his debt obligation no matter what the house is worth. Appreciation/depreciation is a separate thing that isn’t affected by the decision to prepay (at least not first-order affected… it may encourage him to keep up his lawn which would contribute to home values etc.).
March 7, 2011 at 11:57 am
I have a psychological block against pre-paying the mortgage because our house is so upside down I just feel like I’m throwing money into a black hole…but we aren’t planning on defaulting, and the only way we can get our investment out of it is if we keep it long term. I guess I’ll have to get over it someday, eh?
PS: Turtles rule.
March 7, 2011 at 12:54 pm
If you’re not planning on defaulting… then yeah, how much underwater you are or how much the house has appreciated should be irrelevant.
Though if you aren’t underwater, you would be more able to refinance (since banks don’t like refinancing underwater properties), which could cut down interest rates, which would be like getting a part time job. :)
March 7, 2011 at 1:42 pm
Cats rule. Yes they do. Everything else, with the up and the down and the positive and the negative and the tax and interest and principal… eh? No more mortgage for me. Lost my house to foreclosure (yup, housing crisis is totally all my fault). Rent, rent, rent. I don’t know if I’ll ever buy again. If I do, it won’t be through a mortgage though. That I know for sure.
March 7, 2011 at 3:29 pm
*patpatpat*
March 7, 2011 at 3:19 pm
I don’t understand what you don’t get in my article? Not paying a house payment enables me to save enough that it’s like getting free money from working a part-time (or second) job. Nothing more or less…
Not paying $1250 each month frees up money to invest in other things (for instead, I increased my 401k contribution to the max). It’s nice having the extra money as a cushion. My cash flow did increase, I have more money each month that isn’t tied up in a house payment.
Instead of paying over $200,000 in interest, I only paid $40,000 to $50,000. That last sentence is totally unrelated to the topic, but still pretty cool!
Geez, your attacking me and I just recommended you to a fellow blogger theultimatejuggle.com as a great site to read… All I have to say on that is (et tu brutus) ;)
Another irony is that I have one dog, one cat and three turtles… (lol)
P.S. I still love you guys even if you suddenly hate me… Oh, and I’m an editor’s pick in the same carnival :P
March 7, 2011 at 3:27 pm
As we said before, the INTEREST is like a new part-time job. The PRINCIPAL is just saving you’re no longer doing (or are doing elsewhere).
The money that was going to principal before is not like brand new money. It is not like a part-time job. It’s not 1250/month that is “new” money, it’s whatever you were paying in INTEREST. The 40-50K interest is like a part-time job (where you don’t have to show up), but not the 200K or however much your house cost when you bought it. Your entire mortgage payment is not like taking a part-time job, only the part going to interest.
That’s all.
March 7, 2011 at 7:00 pm
Sure, okay, but I still have $1,500 more each month, and to me it’s give me incredible flexibility from a financial perspective.
When I was paying off my mortgage, I created my own amortization spreadsheet that broke down the principal and interest chunk, and I was able to calculation exactly when I would have it paid off, so I know exactly what you ladies are trying to say. The math is quite simple, not rocket science…
It’s been fun ;)
March 7, 2011 at 9:04 pm
See above– Jacq responded to you.
March 7, 2011 at 4:33 pm
Yes, the part going to principal was savings anyway. Avoiding paying the interest is where the new savings comes into play. Principle is savings, in effect….though less liquid. Good to distinguish and know where payments are going. Of course, it’s even better to pay off the mortgage entirely and be debt free.
March 7, 2011 at 4:34 pm
Ayup.
March 7, 2011 at 7:01 pm
I don’t understand how this dude can not understand what you’re saying. All this f***en money shitte is too complicated for me, but even *I* gette that paying down principal is an investment (i.e., savings), while paying interest is a fee.
March 7, 2011 at 8:43 pm
That’s why you get paid the big bucks. :)
March 8, 2011 at 5:45 am
Speaking of which, the invoice for my scintillating comments is in the mail. We take credit cards.
March 8, 2011 at 8:20 pm
Technically, you’re right.
But if you never sell your house, that extra value you get is irrelevant, so I feel more like Money Reasons on this one. (And if I do sell my house, most of the value will have come from inflation rather than from my payments of principal, so that’s another factor that fogs the feelings up a bit, too.)
A third way to think of it is that once you pay off your house, you’re saving the amount you would otherwise be paying for rent minus the amount you’re spending for taxes, insurance (beyond what you’d be paying for renter’s insurance), repairs, and renovation/decor beyond what you’d pay in a rental.
Hey, I know someone who thought the whole payment was like free money and was actually shocked (unprepared) when his next annual property tax payment came due, and this was not even a dumb guy (in other areas).
(Obviously I don’t have a problem with deliberately controversial posts, so long as you’re not just making trouble but are actually pointing out an area where you disagree.)
March 9, 2011 at 5:29 am
No… selling or not selling the house is irrelevant. The actual value of the house is irrelevant. It’s still a debt that has to be paid.
Making the decision to buy or not buy, that’s different. But conditional on having bought the house, the amount going to principal is savings and the amount going to interest is new money.
The only difference is if you’re willing to default on the mortgage. Defaulting is like free money. And shame.
March 10, 2011 at 11:21 pm
Good points. It doesn’t feel like debt, though; it feels like rent. And then it feels like smaller rent.
But that’s only if everything works out perfectly and you can keep affording this rent and not needing to move when you’re upside-down in your loan, etc., in which case it stops feeling like rent and starts feeling like debt again. Okay, you win!
March 11, 2011 at 6:15 am
The interest part is totally rent! It’s some of both.
March 9, 2011 at 8:31 pm
Sure, it isn’t like he has a part time job, he’s just getting more money in his paycheck to do with as he likes. That said, $1,200 is a significant amount of money – what many people make in one paycheck – so I can understand where he’s coming from.
March 10, 2011 at 4:26 am
The part that was going to interest is like a part-time job though (in the sense that it is new money).
March 18, 2011 at 10:52 pm
cats rule dogs drool