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Why Paying Off Your House Early May Be the Wrong Choice

Personal finance guru and radio talk show host Dave Ramsey uses a series of seven steps -- what he calls the "baby steps" -- to help people take control of their financial lives.

Ramsey's baby steps provide a common-sense approach that works for many people, but they makes trade-offs that favor motivation over financial efficiency. In particular, baby step No. 6, "Pay Off Your House Early," pits the motivation of having no debt against the financial reality that you can likely invest at a higher rate of return than the cost of your mortgage.

In the slideshow below, the benefits of paying off a mortgage early are compared to the historical returns seen from three different market-tracking index ETFs to show how that difference can add up to tens of thousands of dollars. The market-tracking ETFs are:

  • Vanguard's Total Stock Market (NYSEMKT: VTI  ) , which attempts to track the broad U.S. stock market;
  • The SPDR S&P 500 (NYSEMKT: SPY  ) , which attempts to track the S&P 500; and
  • iShares MSCI EAFE (NYSEMKT: EFA  ) , which offers broad exposure to developed-market economies outside of North America.

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Read/Post Comments (3) | Recommend This Article (4)

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  • Report this Comment On June 09, 2014, at 2:37 PM, rickw4s wrote:

    I agree with the Fool that we should keep some liquid assets for emergencies.

    But I don't agree with the conclusion of the article.

    Paying off your 5% mortgage is a *guaranteed* 5% return.

    Investing in the market can yield a greater gain, or a negative "gain".

    The choice depends on one's risk tolerance.

    So, given the example of an extra $500 of cash flow, I would suggest paying $50 - $350 extra for mortgage, and investing the rest. (i.e. Diversify your investing: part to mortgage and part to stock/bond investments.)

  • Report this Comment On June 09, 2014, at 8:11 PM, TMFBigFrog wrote:

    Hi rickw4s,

    You're absolutely right that there's a trade-off involved between the "sure thing" of the debt reduction and the decent probability but not guaranteed results from investing. It's a personal choice with a different risk/potential reward profile for each person to make on his or her own, to be sure.

    In our personal case, what tipped us to the "invest" side wasn't the potential return as much as the "we can get at it easier if push comes to shove" aspect of investing vs. paying down the mortgage. I have family members who chose the opposite approach ("get the mortgage paid off") only to lose their jobs and find that home equity off limits with no income to back up a home equity loan.

    It took the combination of easier access in the case of a sustained job loss and the potential of higher returns to convince us, and now that we're on that path, we're glad we took it.

    Regards,

    -Chuck

    Inside Value Home Fool

  • Report this Comment On June 10, 2014, at 7:41 PM, fling93 wrote:

    "I have family members who chose the opposite approach ("get the mortgage paid off") only to lose their jobs and find that home equity off limits with no income to back up a home equity loan."

    If you have emergency savings, you shouldn't really need the home equity loan.

    But more importantly, I'd much, much rather face the problem of being unable to tap into my home's equity than to face the problem of being kicked out of my home due to foreclosure.

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Chuck Saletta
TMFBigFrog

Chuck Saletta has been a regular Fool contributor since 2004. His investing style has been inspired by Benjamin Graham's Value Investing strategy. Chuck also can be found on the "Inside Value" discussion boards as a Home Fool.

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