The morning after you mail that last mortgage check, you feel a certain kind of satisfaction. Coffee has a distinct flavor. The backyard that floods every April, the walls, and the creaky third step all feel more like they belong to you. Cherry Hill, New Jersey-based retired financial advisor Jane Rose put it this way: “I’m such a happy camper.” It’s difficult to dispute that. However, when you’re celebrating, nobody says it aloud at the kitchen table: financial security and happiness aren’t always the same thing.
Nearly half of American families don’t even have a retirement account. The median balance for those who do is approximately $86,900, which is sufficient to pay for about four years’ worth of average household expenses and not much more. For anyone investing extra money in mortgage principal each month, this poses an unsettling question: are you fortifying a stronghold while abandoning the rest of the village?
When you lay it out, the math isn’t very forgiving. The historical case for investing those additional payments in the stock market is quite compelling if your mortgage has an interest rate lower than 6%. Over extended periods, markets have returned about 10% per year. While you’re busy feeling unburdened, the difference between that and a 4% mortgage rate is real money that will quietly compound over decades. People seem to underestimate the significance of that gap over a 20-year period.
However, there are blind spots in the math argument. The unsettling fact that investors are most vulnerable to market fluctuations in the five years immediately preceding and following retirement has been highlighted by financial planner Jason Hull as the “failure to account for downside risk.” It’s not a theoretical risk to sell cheaply during a downturn to pay for living expenses. There is a pattern. Furthermore, even among those who know better, there is ample evidence of the psychological propensity to overtrade, panic-sell, and buy back in too late.
However, investing heavily in home equity creates a different issue. Equity is unyielding. It is difficult to apply to groceries, medical expenses, or auto repairs in February. Financial planners refer to this as being “house-rich, cash-poor,” and it’s more of a trap that people enter gradually over years without fully realizing it than a metaphor. The net worth statement appears to be reasonable. A different story is revealed by the checking account.
The best course of action might not be to choose between maxing out the 401(k) and getting rid of the mortgage. Maintaining retirement contributions, making small additional principal payments rather than heroic ones, and keeping an emergency fund liquid are all part of the more intriguing argument. After paying off a home equity line while retaining his primary mortgage, one homeowner described it as “splitting the difference.”
Behavioral reality appears to be the most important factor, and this is something that the purely numerical arguments consistently undervalue. A person may outperform the technically superior strategy that they perform poorly under pressure if they eliminate their mortgage, sleep better, spend less anxiously, and resist the urge to react emotionally to market fluctuations.
The truthful response, as uncomfortable as it is, depends entirely on your age, risk tolerance, mortgage rate, tax bracket, and actual behavior—rather than your intended behavior—when markets fall 30% in a quarter. You get a framework from the math. What you do with it depends on your psychology.
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