What You're Not Being Told When Advisors Say "Don't Pay Off Your Mortgage"
I read this in an online post, and the question was: Why do advisors say not to pay off your mortgage? The person asking actually has a mortgage rate of 7.3%.
At 7.3%, paying off the mortgage is a guaranteed 7.3% return. The 8 to 10% market return is not guaranteed. It is an average, and averages have volatility built around them. Comparing a guaranteed number to an uncertain one and calling the uncertain one optimal ignores the risk difference between them.
The advice was essentially to borrow at 7.3%, guaranteed, to chase a non-guaranteed 10% in equities, while parking part of it in fixed income paying 4 to 5%. That fixed income slice is a guaranteed loser. You are paying more to hold the cash than the cash earns.
The Pro-leverage Argument Has Hidden Assumptions
It assumes:
Market returns averaging 8 to 10% annually, sustained
You actually invest the difference (most people don't)
You stay employed and can always make the payment
Interest rates cooperate when you want to refinance (historically, there have been periods of elevated rates lasting a decade or more)
Every one of those can fail. And as 2008 proved, they tend to fail together.
The 2008 Scenario Is the Perfect Example
Job loss, equity collapse, and real estate decline hit simultaneously. People with mortgages and leveraged investment portfolios got wiped out on both sides at once.
A bank cannot foreclose on a paid-off home. That is genuine security no brokerage account matches. A brokerage account has no floor. It can drop significantly with no guarantee of when, or if, it comes back on your timeline.
The math-only argument for investing over paying off the mortgage works in a spreadsheet with smooth assumptions. Real life has sequence-of-returns risk and job disruption. Sequence-of-returns risk means the order losses hit in matters more than the average return over time. A crash right when you need to sell does far more damage than the same crash years later, even if the long-term average looks the same.
What I Actually Saw in 2008:
People who believed in leverage over payoff pulled equity out to buy more property. Then:
· The job was gone
· The mortgage payments did not stop
· The emergency fund got consumed by the mortgage payment every month
· Selling the portfolio or property meant taking a loss
· The properties could not be refinanced without a job
That is the real-world outcome of the fully leveraged camp when all the assumptions fail at once.
Concentration Risk and Liquidity
This person claims that during times of crisis, you don't want your biggest asset to be illiquid (a house). Why is the house the biggest asset in the first place? Could it be they have too much house and don't have an adequate portfolio working alongside it? Fix the concentration. Don't turn it into leverage advice.
One should always have adequate liquid funds in fixed income, regardless of whether the house is paid off or not.
Behavioral Finance
Behavioral finance exists because humans are not robots. Markets move on fear and greed.
This person said not paying off a mortgage is a financial decision and paying it off is an emotional decision. They are calling this financially optimal. Optimal means the downside is already priced in. It is not. An option that only works if every assumption holds is not optimal. It is undiversified.
If it's a financial decision, then they should model for the downside as well. This will not survive a stress test. Any advice given before knowing your age, asset mix, income stability, and risk tolerance is not acting as a fiduciary. And if they are not, they have no legal obligation to act in your best interest.
The leverage camp is optimizing for the best-case scenario. Real financial stability requires testing all scenarios.