Should I Pay Off Mortgage Early or Invest?
One of the most heatest subjects of debate in managing your personal finances is whether to pay off your mortgage early or invest the money into other areas that will (potentially) yield a better return. The answer is not easy as it depends on numerous factors. An overview of some of the advantages and drawbacks are given below to help you in making a wise financial decision.
Reasons for Paying Off Your Mortgage Early
1.) You will have peace of mind. A monthly burden is taken off as soon as that large debt is gone. The house is owned 100% by you. That type of security is priceless for some people.
2.) By getting rid of your mortgage it is actually like a guaranteed return on investment of 6%. You are essentially “earning” the interest that you would’ve otherwise paid on it over the balance of the loan period for each dollar that you paid prematurely.
3.) For those that are not savvy investors or have an active personal investment advisor it protects you from committing mistakes. There are no guarantees that if you invest the extra cash into the stock market that it will produce returns.
4.) If you eliminate your mortgage, you now have free cash flow to begin buying those investments for the future. If the stock market is in an extended downturn, you won’t have both a mortgage debt to repay and market losses. If you become unemployed, sick, or disabled, you own your home free and clear and have a lot more financial flexibility to endure difficult economic times.
To see how long it will take to eliminate your mortgage, use the early mortgage payoff calculator on this site.
Reasons to Invest versus Early Mortgage Payoff
1.) The largest reason to not make an early mortgage pay off is the chance to realize large investment returns that may be substantially above your home loan interest rate by two to three times or in those rare cases much more. However, on average, the market returns are around 8%. There are lots of "what ifs" but not selling your portfolio "best of breed" stocks like Apple (AAPL) too early to pay off your home would be a wise choice. Yes, indeed.
In short, why pay off a 5% mortgage when you could potentially be realizing returns of 8-10% (market average) on that money? Well, opponents don’t have to go too far back to find a reason. Those type of investment returns aren’t a sure thing while the saving on your mortgage is guaranteed. On the other side, and it never seems to be taken into account, is that additional expenses of owning a home do go up over time, such as property taxes, HOA, repairs for plumbing, electric, flooring, roof, etc. So, that 5 or 6% rate is now effectively 7-to-8%. Having a mortgage provides you with greater flexibility and more liquidity. This aspect becomes more evident in regions where both housing costs are very high. You just feel more secure having plenty of cash and investment funds for a rainy day, versus having no mortgage at all.
2.) An argument against the “guaranteed return” (of (repaying the loan in full) is because mortgage interest rates are very low together with you being able to fully deduct the annual home loan interest payments on your tax returns. So, then losing that low interest mortgage debt is not all that useful.
3.) If you truly like the idea of a guaranteed return let’s aim high in the 50% area. Contributions to an employee retirement plan will move you on the right path a lot quicker for a number of reasons:
While recently it is true, numerous companies have halted these methods, employer plans frequently do provide matches, usually 50% of each dollar you contribute up to 6% of your salary. So, you're effectively not receiving free money, and forfeiting an instant 50% return, if you're not adding an amount sufficient to get the maximum employer match.
Although at times turbulence and uncertainty exists in the markets, as time passes your money could yield higher returns in the market as opposed to paying down or getting rid of low-interest rate debt. According to trends of past returns, a blend of 60% stocks, 30% bonds and 10% money market would yield in the ballpark of greater than 8% annually during most periods spanning 20-to-30-years. In difficult times that have market downturns or bear markets, people are very skeptical about those times of prolonged stock market gains.
There is a common saying that having low interest debt is having good debt
4.) An additional aspect to take into account is how inflation will change the value. In the future, inflation decreases the value of the dollar. Basically, this will equate into your future mortgage payments being less costly in real terms than they are currently, because the payment will not have the same value when it comes to real buying power.
5.) Interestingly enough, is that many people with excellent credit scores over 720 who have paid off their mortgage have re-checked their credit scores only to see it not increase but to decrease. So, strangely enough, having long-term debt like a mortgage does help your credit score.
