Should I Pay Off Mortgage or Invest the Money? Making a Smart Choice
When you are faced with this situation, often the intuitive answer is to get out of debt as soon as you are able to. You want to be financially free in owning your property, clear of all bank obligations and expenses. Being bound to paying monthly for 30 years or so is not your idea of financial freedom. So when you have the money, why not pay off the mortgage and get done with it? Sounds simple, right?
It’s actually more complex than that. When you think of it, paying off mortgage is not just about avoiding debt. There are other important factors to consider, like return on investment, inflation and tax breaks among others.
Investing the money may be the more economically beneficial option. Why is that?
Return on Investment
For instance, you have a 30-year mortgage for $300,000 and $300,000 in cash. You decide to pay off your debt, and get a guarantee of 4% for paying the mortgage early. However, if you invest the money, you can get as much as 10% returns annually, which is a far cry from the 4% you are expecting if you pay off the mortgage.
Investing in stocks can give you higher returns. Standard & Poor’s 500 Index has an average return of approximately 10%. If you have low risk tolerance, a diversified portfolio of 30% bonds (Credit Bond Index or Barclays Capital U.S. Government) and 70% stocks.
Let’s say your 30-year loan for the $300,000 is at 4%, and you’re making a monthly payment of about $1,433 per month. But you decide to shorten the mortgage to 15 years. According to the mortgage calculator, you need to come up with about $787 for the second monthly payment. Doing so would cut the interest amount by about $116,000, which is a fairly decent interest savings.
But what if you try to invest the extra money instead? For instance, you decide to invest your $787 for 15 years in an investment vehicle that earns 8% annualized returns. According to the MoneyChimp compound interest calculator, this will give you $276,939.
Inflation
Your savings will only come after the full payment is made. This means that the amount payments you are avoiding by paying off your mortgage early are depreciated. According to the present value calculator, your $2,000 saved in 15 years (assuming you pay off the mortgage in 15 years) will only be worth $1,110 today at 4% inflation rate.
Also, given the low mortgage interest rates, it is possible that your interest rate will be lower than inflation rate. If this happens, you are ironically earning more in debt than by owning your property.
Tax Breaks
Mortgage interest rates, when paid, are generally tax deductible when you itemize. However, mortgage interest payments will only replace the standard deduction, and the amount is insignificant. The value of the deduction also lessens over time. This means that mortgage interest offers little to none when it comes to interest savings.
Moreover, investing offers tax advantages. Tax-advantaged investments and accounts can give you tax benefits, examples of which are IRAs and 401(k) plans. Contributions to a Roth IRA are generally not tax deductible, but the money that grows in the account is tax-free.
While the option of investing your money offers economic gain, it is still best to calculate your numbers and take into consideration where you stand financially. Ultimately, your decision should benefit you in all areas. If you need more information about this topic and a specific look into your mortgage plan, please leave your details below and we’ll contact you shortly.