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Your Personal Finance Questions - Answered!

“Should I pay off my mortgage early, or invest?"

Today’s episode looks at a different type of debt. The type of debt with more than $30 trillion outstanding. Mortgages.

 

Today’s question is:

“Should I pay off my mortgage early, or invest instead?”

 

Transcript - Pay Down Mortgage, or Invest?

For most Americans, their monthly mortgage is their households largest monthly bill. And if you are staring at hundreds of thousands of dollars to pay off, it may seem like you have no choice but to plow a lot of extra money into the mortgage every month if you want to pay it down sooner.

Many view extra payments on their mortgage as a type of guaranteed return. If your mortgage is at a 4.5% interest rate, any extra principal put towards your mortgage effectively earns you 4.5%. And paying down a mortgage can certainly provide an added level of comfort for many homeowners.

While that may be true, as we run the numbers with clients, we see more and more that aggressively paying down a mortgage can actually hurt their projected long term net worth.

That is because with the recent low interest rates, we find many homeowners with mortgage rates between 3 and 5 percent. Factor in a couple of percent in inflation, and most Americans are borrowing somewhere between 1 and 3% in real terms for their mortgage. That is very low.

And when you consider that a diversified portfolio of stocks and bonds has historically earned nearly twice that, savers today who are aggressively paying down their mortgage could be costing themselves tens or even hundreds of thousands of dollars in future net worth.

Just as an example. If you have a 30-year mortgage at 3.75% interest and you put $100 per month extra towards that mortgage, you will save yourself about $25,500 in interest.

If you would instead save that $100 per month in an investment portfolio that returns 6% per year, you would see your savings grow to just over $100,000.

That means the decision to pay $100 extra towards your mortgage compared to investing can literally cost you $75,000 in net worth over your life time.

Bump that up to $300 per month and the difference rises to nearly a quarter of a million dollars!

 

Besides that, extra money put into your house becomes very illiquid. If you would save in a Roth IRA or regular taxable brokerage account, your savings would be available to you instantly.

Put that money into your house, and now it can become very hard to access. You may need to take out a HELOC, which can be expensive, have high interest rates, and take time to process. Or, if you are selling your house it may take months before finally finding a buyer.

For these reasons and more, we find ourselves more and more advising clients away from putting excess cash flow towards their low interest rate mortgages. If history is any guide, your money can be put to much better use elsewhere.

Matt Hylland