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Famous financial guru Dave Ramsey has been a long-time advocate of financial discipline and prudent money management. This may include paying off your mortgage early, but only in specific financial circumstances. Making extra payments on your monthly mortgage payment has its pros and cons, shortening the time frame for how long you have to keep making payments, but it’s not always the best money move.
Even if you have thousands of dollars in your savings account or retirement planning options, unexpected things or financial shocks can come up, like job loss, a stock market decline or even a medical emergency. This means it’s not such a bad idea to leave yourself a cushion to cover everything from credit card debt to months of utility bills.
Spending more or even thousands more than you expected on paying your mortgage each month may end up costing you more in the long run.
Not paying off your mortgage early: Pay off early
Dave Ramsey lists many of the benefits of paying extra to pay off your mortgage faster, but he also knows about the drawbacks. He further says:
“Paying off your mortgage early may seem impossible but it is completely possible and people do it all the time, but how can you do it and why would you want to make the extra effort? Paying off your mortgage early will increase your wealth.”
However, one of his more controversial pieces of advice revolves around not paying off your mortgage early, even if you can. This advice contradicts the conventional wisdom of becoming debt-free as soon as possible.
Why you shouldn’t rush to pay off your mortgage
Although some of Ramsey’s advice may challenge conventional wisdom, even famously his own, it’s important to note that personal finance isn’t one-size-fits-all. Factors such as risk tolerance, rate of return on investment, financial goals and personal circumstances play an important role in determining the most appropriate financial strategy.
Like any financial advice, consulting a qualified financial advisor can help individuals make informed decisions tailored to their specific needs and objectives. Here are some reasons and key tips why you might not want to pay off your mortgage early – even if you currently can.
Downsize your home to reduce your debts
Homeownership comes with a big price tag and even more interest. If you can afford to pay more of the principal than the interest on the loan you are in good shape, however, this should not come at the expense of your ability to top up your savings or add to retirement accounts. Ramsey says:
“I tell everyone to never take out more than a 15-year fixed-rate loan and never pay more than 25 percent of your take-home pay. That’s the most you can ever borrow.”
If you’re not in the best position to make additional mortgage payments or even pay it off completely, you should consider selling your home if you have enough equity. This means you can buy a smaller home or another home at a lower price than you can afford to make some profit or pay off this more manageable property faster.
Ramsey also advocates for buyers to avoid VA loans when securing a loan because they are typically more expensive than conventional loans. Ramsey Solutions lists some of the drawbacks of this type of loan:
Zero down payment leaves you unsecured. A small change in the housing market could leave you owing more on your home than its market value! This means you could be stuck in the home until the market recovers or suffer a financial loss if you have to sell the home in a hurry.
You will have to pay a VA loan funding fee of between 1.4-3.6% of the loan amount as of 2020. On a $300,000 loan, that fee could range anywhere from $4,200-10,800. And the fee is usually included in the loan, so it increases your monthly payment and adds to the interest you pay over the life of the loan. Additionally, you may have to include an origination fee from the lender. Oh!
The low interest rates on VA loans are deceptive. While interest rates for 30-year VA loans are typically equal to or slightly lower than 30-year conventional loans, neither loan is a good option. Both will pay you far more in interest over the life of the loan than their 15-year counterparts.
Live within your means instead of paying too much
When it comes to mortgages, being able to afford them doesn’t just mean paying them off quickly – it’s also about being able to make the monthly payments and still live comfortably and save for your future financial security. Ramsey suggests that you be able to answer affirmatively the following questions before considering or securing a mortgage:
- Am I debt free with three to six months of living expenses saved?
- Can I make a 10% to 20% down payment?
- Can I pay cash for closing costs and moving expenses?
- Should the take home payment not exceed 25% of my net salary?
- Can I afford to choose a 15-year, fixed-rate mortgage?
- Can I afford home utilities and maintenance costs?
Lean into the power of compound interest
Ramsey often emphasizes the power of compound interest when it comes to investing. He has said, “He who understands it, earns it. He who doesn’t, pays it.”
They argue that rather than putting aside extra money to pay off a low-interest mortgage, individuals can benefit more by investing that money in vehicles that provide higher returns over time, such as mutual funds or retirement accounts. By taking advantage of compound interest, investors can potentially earn more than the interest saved by paying off the mortgage early.
Choose to remain fluid and flexible
An important takeaway from Ramsey’s stance on not paying off your mortgage too early lies in the importance of liquidity and financial flexibility. By not having a significant portion of your assets tied up in home equity, you have more liquidity to deal with emergencies, take advantage of investment opportunities or meet other financial goals.
This approach is consistent with Ramsey’s emphasis on building a strong emergency fund and the flexibility to deal with unexpected financial challenges.
Be careful of tax benefits
Mortgage interest may be tax-deductible under certain circumstances, especially for homeowners who itemize deductions on their tax returns.
Ramsey often advises listeners to consult tax professionals to understand how this deduction may affect their overall financial picture. In some cases, the tax benefits of mortgage interest may support the decision to prioritize other investments over early mortgage repayment.
Practice risk diversification
Diversification is a fundamental principle in investing, and Ramsey applies this concept not only to investment portfolios but also to financial strategies.
Their “more risk equals more debt approach” means diversifying your financial resources and by not putting all of your funds into home equity, you spread the risk and build a more flexible financial base. This strategy can provide a buffer against economic downturns or housing market fluctuations.
Opportunity costs can put you at a loss
Ramsey often highlights the concept of opportunity cost – the potential benefits of choosing one option over another. By focusing only on paying off the mortgage quickly, individuals may miss out on high-return opportunities in the market.
Ramsey encourages a holistic approach to financial planning that considers a variety of factors, including opportunity costs, to maximize long-term wealth accumulation.
last attempt to go
The bottom line is that Dave Ramsey’s take on not paying off your mortgage early emphasizes the potential benefits of leveraging investments, maintaining liquidity and diversifying risk. While this approach may not resonate with everyone, it underscores the importance of considering multiple factors and long-term financial objectives when making financial decisions.