Investment Decisions— Pay Off Mortgage Early or Invest Extra Money?

If you own a house, you most likely have a mortgage. Paying the monthly installments can be frustrating for many people

Investment Decisions— Pay Off Mortgage Early or Invest Extra Money?

If you own a house, you most likely have a mortgage. Paying the monthly installments can be frustrating for many people. They try their best to balance their budget to make ends meet. Nevertheless, many of them want to pay off this large monetary burden early.

While getting rid of the debt might be tempting, you should think about it carefully. It is an important decision, and there are many factors to consider that include consequences to your net worth and the benefits of being free from debt.

Experts refer to a mortgage as a good debt. Most of them are also against paying off it early. They suggest investing your extra money in a diversified portfolio consisting of 40 percent bonds and 60 percent stocks. If done properly, based on history, you could earn an average of 9.34 percent annually.

If your current mortgage interest rate is lower than the rate of return of your portfolio, then you are better off investing your extra cash through a diversified approach. With current rates at low levels, it doesn’t make a great deal of sense paying off your home loan.

Factors to Consider

There are many things you need when making a financial decision. Some of them are listed here:

1. Cash Flow

You should consider your necessary cash flow requirements. If you are having a hard time keeping up with your monthly payments, and you have a month available, it is smart to pay down your home loan to make it more affordable.

It is important to keep the monthly payments to less than 30 percent of your income. It is also better to pay the debt down instead of just keeping your cash in a no-interest account. However, putting more money into your home could affect your cash flow.

It is also an investment. If you are putting more money into it, you are - diversifying your portfolio.

2. Compute Risk Tolerance

Some people pay off their debt to achieve peace of mind. If you already have savings for your retirement, then it might make some sense. However, if you pay off your home loan without an adequate retirement fund, you will not live a comfortable life as a retiree.

Being free from debt might give you a sense of accomplishment, but it has long-term effects on your finances. You can’t avoid risks if you don’t have an adequate retirement fund.

3. Factor in Long-Term Plans

Repaying your home loan is just one factor of your long-term plan. It is important that you think about the other items in your plan when making a decision. For instance, you might need to move in the future. The savings you receive from getting rid of your home loan might not be enough to cover the moving and closing costs, as well as other expenditures related to the move.

4. Automatic Savings

Most people forget that by paying installments monthly, they are actually saving money, while also paying down the balance. It is only in the early years of a home loan when the big part of the payment goes toward the interest. After that period, you begin to decrease the principal.

If you are not paying the monthly installment, do you think it’s possible that you can save the same amount every month? If the answer is no, then it is best to invest your money instead of paying off your debt. That way you are acquiring more assets while paying down the remaining balance.

5. Compare Risks of Invest and Returns

One positive thing about paying off your home loan is a one-hundred percent risk-free return. You can’t find that in the stock market where everything involves some type of risk. You should consider the opportunity cost of not investing the amount in the market.

You should consult an accountant to provide you with a financial analysis so that you can make smart decisions about where you should put your money.     

6. Benefits of Paying Off Your Mortgage Primary

There are several benefits of paying off your financial burden early. The first one is that you save money on overall interest payments. Paying an extra installment monthly or yearly can give you thousands of dollars in savings.

Getting rid of your home loan would also provide you with peace of mind. You don’t need to worry about paying the monthly mortgage if something unexpected happens such as a family problem or losing your job.

Paying off debt also provides you with a greater cash flow. Your retirement will be more relaxed because you own your home. You can use the freed-up cash you get by eliminating the biggest monthly expense of your household, and you can spend that in various ways, including early gifting to your kids, healthcare, college, and travels.

Reasons Not to Pay Off Your Mortgage Early

There are also several reasons why you should not pay off your home loan prematurely. The first one is that you get a lower return profile than if the money were elsewhere. Top companies in the S&P returned more than 100 percent with dividends in the past ten years, while real estate dropped 2 percent.

Homes are also more difficult to sell than stocks, mutual funds, or bonds. It is expensive to sell a real estate property with commissions sometimes as high as 7 percent. If you need money fast, selling your home is not something you can do to solve your problem.

Current interest rates on home loans are low. If you haven’t refinanced your debt in recent years, then you should do so to get more savings on the interest you pay.

A mortgage is one of the largest tax breaks available to homeowners. If you are in the higher tax bracket, the tax break will definitely work in your favor. Paying the nation 21 loans off early would eliminate that benefit for you, and you will end up paying more taxes each year.  Make sure you consult your tax adviser about this matter before making any decisions.

Being debt-free is a good goal, but you should consider the big picture first. You are probably better off having a small debt and lots of money in other investments than having no debt and no savings. Make sure you think about how getting rid of the debt would affect your overall worth.

Before you pay off your debt, you should take advantage of the employer match for a retirement 401(k) fund. Make sure you have enough money into the fund to get the match. Instead of the mortgage, pay off higher interest debts first, such as personal, car loan, or credit cards. Lastly, start an emergency fund so that you have enough money for unexpected expenses so that you don’t need to apply for loans to cover them.   

Date Of Update: 20 September 2018, 05:49