The dilemma
Lately the internet is full of posts along the lines of "I received/saved 400,000 ₪. Should I pay off the mortgage?"
The most common answer to these posts is "if you can invest with a return higher than the mortgage interest rate, then don't pay it off. If not - pay it off".
And this is where I want to shatter the myth
If we can keep up with the mortgage payments and are not in negative cash flow (expenses greater than income) - don't pay it off!!
Why not pay it off?
I rarely write something so decisive, but in this specific case - it simply breaks my heart to see people putting money into the walls and in effect wasting it out of a mistaken system of beliefs and perceptions. You can do such beautiful things with this money...
Paying off a mortgage is a mindset of survival and scarcity. Keeping the money and letting it work - is a mindset of abundance and growth. That is how people become rich.
The financial logic
Let's start with the financial part and the cost-benefit calculations. When we have a mortgage, we pay both principal and interest. This means the principal gets smaller every month (in CPI-linked tracks it grows in the first years and only later shrinks), so we pay interest on an amount that keeps going down, and the interest itself keeps going down too.
In contrast, when we invest - we get a return on an amount that keeps growing every month because of the compound interest effect.
A numerical example
Let's play with 400,000 ₪, but the principles apply to any amount.
Scenario 1: Paying off the mortgage
Suppose my mortgage currently stands at 400,000 ₪ for 30 years at a fixed unlinked interest rate (KALATZ) of 5%. How much will it cost me over the 30 years?
The total cost of the money in such a case will be 373,000 ₪. In other words - over the 30 years I will repay the 400 I owe plus another 373.
Scenario 2: Investing in the S&P 500
If I invest 400,000 ₪ for 30 years in the S&P, at 9% a year, it will turn into 5,307,000 ₪. There is tax on that, so net I will be left with 4,080,000 ₪. Minus the 400 I invested, that comes to more than 3.6 million net profit after tax.
In other words - if I pay off the mortgage - I gain 373,000 shekels and lose 3.6 million!!!!
Scenario 3: Monthly investment of the freed-up money
But there is an important counter-argument: if I pay off the mortgage, money is freed up every month and I can invest it. Suppose I have iron discipline and invest all the money freed up from the mortgage. In the example above that comes to 2,147 ₪ a month.
If I invest 2,147 ₪ a month in the same S&P for 30 years - that is a total investment of 773,000 ₪ and I will have 3.9 million gross, which is about 3.1 net after tax. That means a profit of 2.37 million. Definitely not bad, but still less than the 3.6 from a single investment at the start of the period.
But I want to sleep well at night
And what if I want to sleep well at night? And I'm afraid to invest in the S&P? Then I will invest in a "general" track that gives "only" 4.5% a year (note - a return lower than the mortgage interest rate).
In such a case, in 30 years, I will have almost 1.5 million, and after tax - 1.1 million. That is - a profit of 823,000 ₪. Even that is still much better than paying off the mortgage!
What about a CPI-linked mortgage?
Suppose the interest on the mortgage is 3% and the expected inflation for the next 30 years will also be 3% a year.
In such a case - the cost of the 400 will be 582,000 ₪ instead of 373,000 ₪.
The investment profits do not change, of course, that is - 3.6 million in the case of a one-time investment in the S&P and 1.1 million in a general track. In this case too the investment wins big!
The winning argument
And now for the argument that in my opinion is the winner: I can pay off the mortgage whenever I want. In a week, a year, five years or ten years.
But if I paid it off - I cannot take the money out of the walls
It is possible, but difficult and much more expensive than a regular mortgage. In other words - not paying off is a reversible decision. Paying off - is a one-way street.
And if we keep the money with us - we have money. If we need it (and not just because we feel like a trip abroad) - we can use it. In case of losing a job, a serious medical problem, heaven forbid, or any similar situation.
In summary
The bottom line - in almost every possible scenario - investing the money yields much more than paying off the mortgage. Paying off a mortgage is a decision that can be made at any time, but once we have paid it off - we cannot go back.
Next time you manage to save some money - I recommend giving it a lot of thought before paying off a mortgage with it.