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The housing market, and home prices, have exploded over the past year as many took advantage of low interest rates to get their first home or buy a bigger house. Likewise, the stock market has been going gangbusters over the past year.
So if you’ve got some extra cash on hand, it can be difficult deciding whether to put those funds toward paying off your mortgage early, or investing it. Both options could create two different ways of making more money.
If you pay off your mortgage early, that means those old monthly payments can go toward saving or investing in something else. If you invest your spare cash, there is an opportunity to gain larger returns for the same, or different, purposes.
We’ll walk you through both options to help you decide what’s best for you.
Pros Vs. Cons to Paying Off Your Mortgage Early
From a purely financial angle, conventional wisdom might suggest you pay off your debts first. But these decisions are not always so black and white. As always, your personal life situation should be the primary determinant of which direction you choose to go. We’ll walk you through the reasons you should—or should not—pay off your mortgage early.
Pros to Paying Off Your Mortgage
- Savings on interest payments. You could save a lot of money by removing your mortgage loan off your plate before the term ends. For one, there’s a significant savings on interest payments, to the tune of thousands or tens of thousands of dollars.
- Getting rid of debt. No one likes owing large amounts of money to a lender, especially if it spans 15 or 30 years like most mortgages. Paying the mortgage off early means one less big bill to worry about. Compared to all other expenses associated with owning a home, the principal plus interest payments make up the lion’s share of the debt load.
- Grow your equity. Paying down your mortgage faster means accumulating more equity in your home at a quicker rate. This also means you could take another route and refinance your loan, which can lower your monthly mortgage payments. You may also be able to tap that equity through a home equity loan or home equity line of credit (HELOC), which you can use for tax-deductible improvements that increase your home’s value or other major expenses.
Cons to Paying Off Your Mortgage
- There’s potentially a missed opportunity. Any additional money you spend to pay off your mortgage faster is money that is no longer available for other investments. It could be your 401(k), a rainy-day fund, a buying opportunity like a boat or car, or being able to take advantage of an investment in the stock that could produce a greater return.
- Your money is inaccessible. A home cannot be sold and converted to cash overnight, even if it’s an all-cash sale. In the event of an unexpected medical emergency or other critical financial situation, selling your property to get the funds you need will be a drawn-out process, and potentially for less than the house is worth if you are in desperate need.
- Missing out on tax breaks. Money that goes toward paying off your mortgage faster means less available to put into your tax-deferred retirement accounts. You also risk missing out on tax deductions for mortgage interest if you itemize when you file your taxes.
Pros and Cons to Investing Instead
Most people cannot wait to shed their mortgage debt burden and own their home outright. But it is not always the best financial idea to devote a lot of money to paying off your mortgage quickly. This is especially true when mortgage rates remain historically low, and your monthly payments are very affordable already. Instead, it allows you the latitude to add to your nest egg through other investments.
Pros to Investing First
- Put your money to work sooner for faster returns. The main reason to invest your money instead of paying down your mortgage faster is the bigger return on investment. The average annual stock market returns have exceeded mortgage interest rates recently, offering an opportunity to benefit from the difference.
- More cash available when you need it. Unlike a home that ties up your money, and only appreciates gradually in value, investing in more liquid financial assets means you can easily sell and access your money if you need to.
- 401(k) match. If you have an employer-sponsored retirement account, and your job matches your contributions, then that is additional earnings over time from investing the extra money. These contributions are also pre-tax. Meaning, you can invest larger amounts.
Cons to Investing First
- The higher the reward, the higher the risk. It would be an understatement to point out that there is a high level of volatility in the financial markets compared to the housing market in terms of owning a mortgage. Putting your cash in any stock investment is a risk, especially if you are taking a short-term approach. Only go down this path if you have a higher risk tolerance, and financial cushion.
- Not owning your home sooner poses risks. Investing rather than paying off your mortgage faster means you will owe the lender for longer, and it can also take longer to build up equity in your house. There is also the risk of foreclosure if you cannot make the monthly payments, especially if you blew all your reserves on investing in the stock market.
Types of Investments
If you decide to invest your money instead, you could put that extra money each month in a fund that tracks the S&P 500 Index. Over the past 10 years, the S&P 500 has had an average annual return of 13.6 %.
So there is a strong chance that after 20 years (assuming it’s a 30-year mortgage), you could have more money from investing than if you decided to pay off your mortgage at a faster rate.
In fact, it is entirely possible that if you made enough from your investment, you could use some of your returns to pay off your mortgage debt faster, too.
How Do I Know Which Route is Best For Me?
Given the pros and cons of both options, the best solution might be taking advantage of the historically low mortgage rates to trim your debt, while also investing in your future.
If all your ducks are in a row, you could significantly lower your mortgage debt obligations by refinancing to a lower interest rate as well as reducing your mortgage term length. And you would be able to pay off the loan at a faster rate.
The savings from either of the above options could then be put towards investing in the markets. The end result is you save money on meeting your mortgage debt overall while still being able to benefit from the higher returns offered by the stock market.