Paying Off Mortgage Or Investing It - What Is The Right Choice for You
If you're a homeowner with a mortgage, you’ve probably considered whether or not you should pay off your loan early. On the one hand, clearing the debt before the due date will drastically reduce it's long term cost, saving you tens of thousands of dollars in the process. On the other hand, that extra capital may be better put towards investments that can set you up comfortably for retirement.
Unfortunately, there’s no clear answer as to which option is better, and the correct course of action depends on several factors.
Paying Off Mortgage Early - Pros And Cons
- Cheaper in the long run: Every monthly payment carries interest, which, after 30 years, can amount to a large sum of money. In most cases, your payment may not even comprise of equal parts interest and principal for over a decade into the loan. Paying the debt off early can result in tens of thousands of dollars in savings
- Frees up cash flow in the future: For most people, their monthly housing payment is one of their largest expenses. The sooner you can clear your home loan, the sooner you’ll have more cash to use for other purposes, such as saving, investing, traveling, and renovations
- Receive a predictable rate of return: Paying off your home early will reduce the amount of interest you pay in the long term. Instead of saving, some people choose to think of this as a return equal to the interest rate your financing carries
- Higher returns may be out there: If the economy is doing well, there may be investment opportunities that pay more than whatever you would save by paying off your home loan early
- Ties up liquid capital: If a good chunk of your income is going towards repaying your home financing, there may not be much left at the end of the month for other things. Not only can this lead to financial hardship, but it may also prove to be an issue if unexpected expenses arise, such as car repairs or a medical emergency
When You Should Pay Off Your Mortgage
There are certain scenarios when paying off a home loan early is beneficial. These include the following.
When Your Interest Rate Is High
When it comes to paying off your mortgage vs. investing, two of the most important factors to consider are interest rates and current market conditions. Our modern economic system works on the fundamental assumption that markets go through periods of expansion and contraction. When the market contracts, the federal reserve lowers interest rates to stimulate economic activity. When the market is in an expansionary phase, interest rates are high to curb inflation.
If your mortgage has a higher interest rate than what other investment vehicles are currently paying, it makes more financial sense to pay it off first.
Another way to take advantage of low-interest rates is by undergoing a mortgage refinancing. Even if you don't plan on paying off your home loan early, securing a reduced interest rate could still save thousands of dollars over the lifetime of the debt.
You’re Risk Averse
Investments don’t have a guarantee of working out, and some individuals don’t have an appetite for such risk. By paying down your mortgage before the term end, you know exactly how much you’ll be saving, and this amount may be adequate for some.
It's Financially Feasible
If paying off your home loan doesn’t cause financial strain, and the interest rate is higher than other investment opportunities available at the present moment, you may want to consider paying down your home quicker than planned. Not only will you save money, but you’ll enjoy the peace of mind of being mortgage-free.
Making An Investment - Pros And Cons
- Allows you to take advantage of investment opportunities: If you decide to pay off your mortgage early, it could mean you have little funds available to take advantage of investment opportunities. Depending on the current economic climate, some investments may have a higher rate of return than you would receive from paying off your home loan early
- Mortgage rates are low: Home loans carry some of the lowest interest rates of any personal debt. If you have limited disposable income but still want to invest in your future, you may be tempted to take out financing for purchasing stocks, bonds, or CDs. Since the interest rate on personal lending products will be much higher than your mortgage rate, you're better off taking whatever money you would have used to pay down your home loan and divert it towards investment opportunities
- Can pay off in the long run: If done right, investing instead of increasing your monthly payments can lead to a much greater financial reward and potentially set you up for retirement
- Investment might not work out: The concept of investing extra cash instead of using it to pay off your mortgage early only makes sense if the investments pan out. Any financial instrument that will provide a higher return than paying down your home loan before the due date is likely to be a mid to high-risk outlay, meaning there’s no guarantee it’ll pay off
- Paying off a mortgage early may give a better return: In certain market conditions, retiring your home loan before its maturation date can yield a better return than most investment vehicles. This is especially true if you have a balance with an interest rate of between four and five percent, and refinancing isn’t an option
When You Should Invest
Let’s delve into situations when investing is the better option than paying off a home loan.
When Your Interest Rate Is Low
If your home loan carries a low interest rate, then it may be worth investing excess funds instead of using them to pay off the debt early. This is especially true if the market is in an expansion and investments are yielding a high return or if an attractive investment opportunity becomes available.
Because you locked in a low interest rate, you won't be accessing a very high return by paying it off early. By extension, certain financial instruments, such as stocks and bonds, may yield a considerably greater return, especially if the fed funds rate is high.
When You're Young
Youth is when you should take the most chances when it comes to investing. The older you get, the more difficult it is to recover from an investment gone wrong, and if you still have many years left on your mortgage and market conditions are right, it may be worth investing extra funds instead of putting them towards your home loan.
When You Can Refinance
If you're able to refinance your mortgage with a lower interest rate, you may find yourself in a position to enjoy the best of both worlds. The reduced interest rate will save you money, and any extra capital you may have can be put towards investments.
Paying Off Vs. Investing - Choose Your Strategy
When it comes to paying off early vs. investing, the answer isn’t as simple as black and white. Not only does it depend on interest rates and market conditions, but also what level of downside you're willing to assume. Below, we’ll explore four strategies that aim to balance mortgage payments and investing based on risk tolerance.
- Low-risk: If you have a low tolerance for risk or are over the age of 50, your best option is to pay down your mortgage early and invest what you can. If you decide to go this route, there are several factors to consider. First, even if you're happy with the lower return gained from paying off your home loan early, you still need to set yourself up for retirement, which means putting some money into an investment vehicle. Second, as long as your credit score allows you, refinancing is always an option if a lower rate becomes available
- Medium-risk: Most people will find themselves in the medium-risk category, and it’s not a bad place to be. If you have a favorable home loan rate, then you don't have to rush in paying it off before the agreed-upon term. Instead, you can use some of your excess cash to set yourself up nicely for the future by putting it into stocks, ETFs, 401ks, or any other secure vehicle. The best way to do this is by taking whatever monthly amount you're willing to put towards investments/mortgage payments and split it down the middle 50/50
- High-risk: If you're young or willing to take on a more significant level of risk than others, you may decide to forego paying off your home loan early (making only the interest payments instead) and direct all available funds towards investment and savings opportunities. If this goes well, it’ll position you well for retirement and result in the largest return of all the three strategies
Determining whether to invest or pay off your mortgage early isn’t an easy decision to arrive at. In most cases, it depends entirely on an individual's personal goals, risk tolerance, and financial situation. This decision, as we’ve covered, is also heavily influenced by interest rates and current market conditions which can drastically impact a borrower’s perspective.