It might be tough to strike the right balance between paying off your mortgage versus investing. It might be tempting to chip away at your home loan faster and save money on interest. But on the other hand, investing for your future might also be an important financial priority.
Ultimately, it may make more sense to invest your money if your expected rate of return exceeds the interest you would pay on your mortgage. However, it’s difficult to guarantee a certain return on your investment, and everyone’s financial situation is different, so it’s important to weigh all the pros and cons before deciding.
Let’s look at some reasons you may want to invest or pay off your mortgage and the downsides of each approach.
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Whether your income is increasing or you received a cash windfall, you might be debating where to put the extra money. Although some people may put the money toward their mortgage, some may invest it in a retirement savings account or other investment vehicles.
Making extra payments on your home loan could save you money on interest and get you out of debt faster. But on the flip side, investing your extra cash could earn money over time that might sometimes exceed what you save on interest.
If you secured a mortgage with a low interest rate that is easy to beat with your rate of return from investing, you would see a greater financial benefit from investing. However, keep in mind that investing always entails some risk, and there’s no guarantee of a specific rate of return.
Let’s look at some pros you might benefit from if you paid off your mortgage ahead of schedule.
Your mortgage accrues interest on a monthly — or in some cases, daily — basis. So if you make extra payments on your mortgage, you could save money on interest charges.
Let’s say, for example, you have a 30-year mortgage of $200,000 with a fixed interest rate of 5%. How much money would you pay by the end of your mortgage?
If you make your regular mortgage payments over 30 years, you’d pay $386,513 in total.
If you pay an extra $200 per month on top of your mortgage payments, you’d pay $325,352 in total, which saves you $61,161 in interest.
If you pay an extra $500 per month in addition to your mortgage payments, you’d pay $285,391 in total and save $101,122 in interest charges.
Your savings may vary depending on when you choose to make your extra payments. A larger proportion of your money goes into interest payments at the beginning of your repayment term while your loan balance is still high.
As you approach the end of your loan term, the loan balance gets smaller, and a larger portion of your payments go toward paying down your principal balance. You could use a mortgage calculator to view your loan schedule and estimate how much you’d save in interest by making extra payments.
Along with saving money on interest, making extra payments on your mortgage would help you finish your payments sooner. Let’s go back to a 30-year mortgage with a 5% interest rate.
If you make extra payments of $200 per month, you would get out of debt after 22 years.
If you make payments of $500 every month, you’d pay off your loan in 16 years.
The average monthly mortgage payment in the U.S. in January 2022 was $1,162 for a 30-year fixed-rate mortgage. If you could eliminate your mortgage payment, you’d free up more of your cash flow for other financial goals.
Funneling extra money into your mortgage would also help you build equity in your home more quickly. Equity measures the amount of your home that you own. It’s the difference between the amount you owe on your mortgage and the current value of your home.
If your home is valued at $400,000 and you owe $300,000 on your mortgage, you have $100,000 in equity. By paying down your mortgage balance faster, you would increase the equity you hold.
This could be helpful when you want to borrow a home equity loan or home equity line of credit (HELOC), both of which require you to hold a certain amount of equity in your home.
Although paying off your mortgage quicker has several significant advantages, it doesn’t come without a few cons. Here are things to keep in mind when paying off your mortgage.
One potential con of making extra payments on your mortgage is losing liquidity. If you’re tying up most of your money in your home, you might not have fast access to cash when you need it.
Before paying off your mortgage early, it may be a good idea to save up an emergency fund that could cover between three and six months of living expenses. You might also want to invest some money in stocks, mutual funds, or other investment vehicles that you could quickly liquidate if you need cash.
If you have a lower interest rate on your mortgage, paying it off early might not make the most financial sense.
As of May 2022, the average 30-year fixed mortgage rate was 5.27%, according to the Federal Reserve Bank of St. Louis. Compare that to the 30-year rate of return for the S&P; 500 index, which is around 10%, according to the investing community, Seeking Alpha.
If you allocated your extra money for mortgage payments, you might miss out on the returns you could potentially get from investing.
Another potential con is losing access to the mortgage interest tax deduction. Homeowners who itemize their taxes could claim the interest they pay on their mortgage to lower their taxable income. If you pay off your mortgage early, you would lose this tax break.
As you’re weighing paying off your mortgage versus investing, consider these advantages of investing your money.
Investing might help you increase your future wealth. By investing in a retirement plan or other types of investment accounts, you might set yourself up with wealth that could continue to grow over time.
Investing your money could also have a higher annual return on investment than paying down your mortgage early, especially if your mortgage rate is low. You could even use some of your investment returns to pay down your mortgage. However, that might slow down the growth of your investment wealth.
If available, it also makes sense to max out an employer’s 401(k) matching benefit because that represents a 100% return on investment rate on a percentage of your contributions.
By investing your money in stocks, bonds, or commodities, you’d be likely to have better asset liquidity because you could easily sell your assets to get cash.
On the other hand, if most of your wealth is tied up in your home, you’d have to sell the home or apply for a loan against your home to access liquid funds.
Diversifying your portfolio helps minimize risk and provides more financial stability. Instead of pouring extra money into your mortgage, it may be more beneficial to diversify it across other assets, such as mutual funds, stocks, bonds, and emergency savings.
Investing always entails some risk, and the stock market tends to be more volatile than the housing market.
You can’t predict exactly your rate of return on investments. You may also need to leave your money in the stock market for a good chunk of time to weather volatility in the market.
If you’re new to investing, it might take some time to gain the knowledge you need to go about it in the best way.
There are many investment options, from 401(k)s and IRAs to brokerage accounts to cryptocurrency exchanges. It may take some trial and error to home in on the best investment strategy for you.
If you sell assets such as stocks for a profit, you may have to pay capital gains tax. You pay a higher capital gains tax rate on short-term gains than long-term gains.
To avoid a short-term capital gains tax bill, you may need to hold on to any assets for at least a year before selling.
Since there are advantages and disadvantages to paying down your mortgage and investing, it might make sense to do both. By working on both goals, you could work on increasing your future wealth while reducing your mortgage and building equity in your home.
As you think about how to strike the right balance, consider the terms of your mortgage, especially the number of years left in your repayment term and your mortgage rate. At the same time, learn about the ins and outs of investing before you dive in.
Don’t forget about other financial priorities, such as paying down high-interest credit card debt. You could also refinance your mortgage to get a shorter repayment term. Becoming debt-free sooner would free up more money in the future for investing.
Another reason for refinancing is if you have a high interest rate, but your current credit score might get you a lower mortgage interest rate.
Finally, consider other avenues for building wealth. If you could increase your income through one of the best side hustles or passive income streams, you might have an easier time paying off your mortgage, investing, or achieving other financial goals.
There’s no one-size-fits-all answer to what age is good to have your mortgage paid off. Some experts recommend aiming to pay off your mortgage by age 45, but that goal may not be possible for many homeowners.
If you could pay off your mortgage before you retire, you won’t have to worry about making that monthly payment during retirement. This would leave more money in your retirement account for your living expenses and travels.
Paying off your mortgage is unlikely to lower your homeowner’s insurance cost. Your lender typically pays your insurance company directly when you have a mortgage. After the loan is paid off, notify your insurance provider and set up payments independently.
There may be some money left in your escrow account you could apply to your first few payments. Note that homeowner’s insurance is no longer required after you pay off your mortgage, but it’s a good idea to keep it in case of damage to your home.
As a beginner investor, you may start by putting your money in low-risk accounts. You could choose one of the best savings accounts or certificates of deposit (CDs) that receive a high yield. This would give you a low but certain rate of return.
It may also be a good idea to invest in your employer’s 401(k), especially if your employer offers a matching benefit. You could also take a moderate level of risk with a higher potential reward by investing in index funds, mutual funds, or exchange-traded funds.
You could also invest in stocks or buy cryptocurrencies, but these options tend to be riskier. Our recommendations for the best investment apps could help you get started.
You could make a monthly income from stocks, but it might not be enough to live solely off it. One way to make income from stocks is to invest in dividend-paying stocks. Larger companies often pay quarterly dividends to investors.
Keep in mind that you’ll likely need to pay income tax on earnings you make from stocks unless you're earning this income from certain retirement accounts.
Everyone’s financial situation is different, and your decision about paying off your mortgage versus investing comes down to several factors. Consider your financial decisions and how they align with your risk tolerance and your other financial obligations. If you hold other high-interest debt, paying it off might be your priority.
When thinking about how to manage your money, you don’t need to go all-in on a single strategy but could rather strike a balance between paying your mortgage and investing. Working on both goals at the same time could chip away at your home loan while increasing your wealth and securing future financial stability.
You could also consult a financial advisor, which might help align your current personal finances with your financial planning goals.
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This article Paying Off Mortgage vs. Investing: How to Strike a Balance originally appeared on FinanceBuzz.
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