The Great Debate: Mortgage Freedom Or Investment Opportunities?

Paying off your mortgage or investing your money elsewhere is a common dilemma for homeowners. The answer depends on your individual circumstances, including your risk tolerance, financial situation, and how close you are to retirement.

Paying off your mortgage early can save you thousands of dollars in interest and give you peace of mind. On the other hand, investing your money can potentially earn you higher returns, increase your future wealth, and provide better liquidity.

Consider your financial goals and risk tolerance to decide which option is best for you.

Paying off your mortgage early can save you thousands in the long run

Paying off your mortgage early can save you thousands of dollars in interest. However, before you start throwing money at your mortgage, there are a few factors to consider.

When you make a mortgage payment, it is split between the principal (the amount of money you originally borrowed) and interest. During the first few years of your loan, most of your payment goes towards interest. As you pay down your principal, you owe less in interest, and a larger percentage of your payment goes towards the principal.

How to pay off your mortgage early

You can apply extra payments directly to the principal balance of your mortgage. Making additional principal payments reduces the amount of money you'll pay interest on before it can accrue, knocking years off your mortgage term and saving you thousands of dollars.

For example, let's say you borrow $150,000 to buy a home at 6% interest with a 30-year term. By the time you pay off your loan, you'll have paid a total of $273,757.28, including $150,000 in principal and $123,757.28 in interest.

Now, let's say that you pay an extra $100 every month towards the loan. At the end of the term, you'll have paid a total of $198,170.57 in interest – $45,586.71 less than if you hadn't made any extra payments. You'll also pay off your loan 81 months earlier.

Things to consider

• Risk tolerance: Paying off your mortgage is traditionally a safer move as it's predictable and you'll know exactly how much you're saving. Investing, on the other hand, comes with risk as markets fluctuate.
• Stage of your mortgage: If you're in the early stages of your mortgage, it's beneficial to be aggressive with your payments as your money is going towards the interest on the loan, not the principal. If you're well into a 30-year mortgage, you're likely paying more of the principal and less interest, which can open up room to focus on investing.
• Financial situation: Make sure you have enough liquid assets to cover your needs and any unexpected expenses. If most of your money is tied up in your home and an emergency arises, you might need to take out a new loan or line of credit, cancelling out any advantage gained from paying off your mortgage.
• Interest rate: If you have a high-interest rate, it's a good idea to make paying that off a priority. Credit cards and personal loans commonly come with high-interest rates, so it's best to focus on paying those off first.
• Emotional decision: Some people are uncomfortable with the idea of heading into retirement with debt. While it's understandable, it shouldn't be the driving force behind your financial planning. Take an objective approach and see how your portfolio is doing. If your investments are earning strong gains, you may want to make them a priority.

Investing in your future wealth increases your wealth over time

While paying off your mortgage early can be tempting, investing in your future wealth can be a wiser financial decision. The stock market has historically returned an average of about 10%, and in some years, the returns have been much higher. This means that if you invest instead of paying off your mortgage, you could make a substantial profit. Of course, there are no guarantees, and the stock market can be volatile, but if you invest for the long term, you are more likely to see positive returns.

Additionally, investing in stocks, bonds, and mutual funds provides you with more liquidity. If you need cash quickly, you can easily sell these investments and access your money. In contrast, if you tie up all your money in your home equity, it will be challenging and time-consuming to convert it into cash if you need it in an emergency.

Another benefit of investing is the potential for employer-matching contributions if you invest in a retirement account. Some employers may match your contributions up to a certain percentage, giving you free money to grow your wealth.

Furthermore, investing allows you to build wealth for the future. By investing in stocks, bonds, or even a small business, you are increasing your future wealth. This wealth will continue to grow over time, setting you up for a more comfortable financial future.

Finally, investing allows you to diversify your portfolio and reduce risk. By investing in various assets, you can balance your risk and take advantage of different investment opportunities.

However, it is important to note that paying off your mortgage early can also have benefits, such as saving on interest and achieving the peace of mind of being debt-free. Ultimately, the decision to invest or pay off your mortgage depends on your financial situation, risk tolerance, and personal preferences. Consulting a financial advisor can help you make the best decision for your circumstances.

Paying off your mortgage first may be a better option if you're nearing retirement

Paying off your mortgage before you retire can be a good option if you are looking to reduce your baseline expenses. If your monthly mortgage payment is a large chunk of your expenses, you will be able to live on less once that payment is gone. This can be especially helpful if you have a limited income.

Paying off your mortgage can also save you money on interest payments. Depending on the size of the loan, interest rate, and term, interest can cost hundreds of thousands of dollars over time. Paying off your mortgage early frees up that money for other uses.

If your mortgage rate is higher than the rate of risk-free returns, paying off your debt can be like earning a risk-free return equivalent to that interest rate. Compare your mortgage rate to the after-tax rate of return on a low-risk investment with a similar term, such as a high-quality, tax-free municipal bond. If your mortgage rate is higher, you would be better off paying down the mortgage than investing the money.

Paying off your mortgage can also give you peace of mind and increase your financial flexibility in retirement.

However, there are some downsides to consider. Paying off your mortgage early reduces your liquidity, as it moves your most liquid asset (cash) into a very illiquid asset (your home). It can also mean missing out on potential investment returns, especially if your mortgage rate is lower than what you could earn on a low-risk investment with a similar term.

Before making a decision, it is important to consult with a financial advisor, who can help you understand the impact of this choice on your portfolio.

Investing in the stock market gives you the potential to earn more money

The stock market has historically delivered higher returns than paying off a mortgage early. While paying off your mortgage early guarantees a return on investment in the form of interest savings, the potential returns from investing in the stock market can be significantly higher.

For example, let's say you have a 30-year mortgage of $200,000 with a fixed rate of 4.5%. Your monthly payments would be $1,013, and you'd spend a total of $164,813 in interest over the life of the loan. If you're able to pay an extra $300 per month, you'd save $67,816 in interest and shave off 11 years and one month from your repayment period.

However, if you choose to invest that extra $300 per month in an index fund that tracks the S&P 500, which has historically returned an average of 10% to 11% annually, you could end up with around $160,780 at the end of 19 years (the time it would take to pay off your mortgage early). That's more than double your potential interest savings.

Of course, investing in the stock market carries more risk than paying off your mortgage early. The stock market can be volatile, and there is always the possibility of losing some or all of your investment. On the other hand, paying off your mortgage early provides peace of mind and reduces your overall debt.

Ultimately, the decision to invest in the stock market or pay down your mortgage depends on your individual financial circumstances, risk tolerance, and investment goals. It's essential to carefully consider your options and seek professional advice before making any decisions.

Paying off your mortgage first may be a better option if you have a high-interest rate

Mortgages are tied to the value of your home, so they often come with low-interest rates. If your interest rate is 4.5% or lower, you may want to focus on investing. However, if you have a high-interest rate, you'll want to make paying off your mortgage a priority. Credit cards and personal loans commonly come with high-interest rates, so it's best to focus on paying those off first.

If you're still in the early years of your mortgage, it's typically smarter to pay down your mortgage as much as possible to avoid paying more in interest over time. Making extra payments early on and reducing the principal amount on which you're being charged interest could help you save thousands of dollars in interest over the life of the loan.

Additionally, paying off your mortgage early can provide peace of mind and make you feel more secure, especially if you're close to retirement. It can also help you build equity in your home more quickly, which can be useful if you want to refinance or take out a home equity loan or line of credit.

However, it's important to consider the opportunity cost of paying off your mortgage early. Any extra money you spend on your mortgage is money that could be invested in other financial goals, such as retirement savings or emergency funds. Additionally, paying off your mortgage early may result in losing tax deductions on mortgage interest payments and could lead to prepayment penalties charged by your lender.

Frequently asked questions