Deciding the best way to allocate your hard-earned money can be challenging. For homeowners, a common dilemma is whether to pay down your mortgage faster or invest that extra cash elsewhere.
When it comes to raw numbers, the math favours investing rather than paying down a mortgage.
However, life isn’t just numbers on a calculator. Your unique situation will determine whether you should funnel your money into your home or save it for the future.
Pros & Cons of Paying Down Your Mortgage
Here are some reasons to pay down your mortgage:
- Reducing debt: One of the most compelling reasons to pay down your mortgage is the peace of mind that comes with reducing your debt. It’s one less payment to make every month.
- Increasing equity: A tangible asset that can be leveraged for future financial needs, such as home renovations or investment opportunities.
- Interest savings: Every additional dollar you pay towards your principal decreases the total interest paid over the life of your loan. This can save thousands of dollars in interest and shorten the length of your mortgage, freeing up future cash flow for other investments.
- Tax benefits: Depending on your specific circumstances, paying down your mortgage may offer tax advantages, such as reduced property taxes or interest deductions.
However, paying down your mortgage instead of investing has its downsides, including:
- Non-liquid assets: Unlike stocks or bonds, a home isn’t easily converted to cash. This lack of liquidity means you’re less flexible in responding to unexpected expenses or investment opportunities. Additionally, if the real estate market experiences a downturn, the equity you’ve built may not increase in value as anticipated.
- Opportunity cost: By allocating funds to your mortgage, you may miss potential higher returns from other investments, such as stocks, bonds, or real estate investment trusts (REITs).
- Prepayment penalties: Depending on the type of mortgage you have, you may incur a fee if you pay off your loan too early or make substantial additional payments towards the principal. These penalties are designed to compensate lenders for the interest income they miss due to early repayment but can cost you thousands.
Pros & Cons of Investing
If you decide to invest your extra cash instead of putting it towards your mortgage, you may benefit from:
- Higher potential ROI: Historically, the stock market has outperformed other investment options, including real estate. By investing in a diversified portfolio, you can potentially achieve substantial long-term growth.
- Liquidity: Homes can tie up your wealth for long periods, but stocks, bonds, and other market investments could be sold quickly if you need to access your money.
- Diversification: By diversifying your investments across various asset classes, you can reduce your overall risk and improve your chances of achieving consistent returns.
When considering investing, take a moment to also consider the potential cons:
- Market volatility: The stock market is subject to fluctuations. A well-diversified investment portfolio, combined with a long-term investment horizon, can help mitigate these risks.
- Complexity: Investing can be complex, requiring knowledge and research. Consulting with a financial advisor can help you navigate the complexities and make informed decisions.
Comparing Paying Down Your Mortgage vs. Investing
Let’s take a closer look at the numbers. Let’s say you have an extra $500 a month that you can use to pay down your mortgage or invest. Using some straightforward math to illustrate potential outcomes, we’ll break down this decision.
Assume you have a 25-year mortgage with an outstanding balance of $400,000 and a fixed interest rate of 4.5%. Not including any additional costs, your monthly payment is around $2,214.00, and by the time you pay it all off, you’ll have paid over $216,000.00 in interest. By allocating the extra $500 monthly directly towards your mortgage principal, you save yourself around $83,700.00 and 7 years.
Consider investing the same $500 with a conservative average annual return of 7%. After 18 years (the time it would take to pay off your mortgage early in our first example), you have around $210,459.00. This is almost the entire interest you would pay over the entire 25 years, and you still have 7 more years to invest.
What About Interest Rates?
Our calculations were all done based on fixed rates. When interest rates are high, like they are now, that may skew the numbers toward paying down debt rather than investing. It also doesn’t have to be one or the other; you can split your money and try to get the best of both worlds.
Finding the Right Approach for You
A strategic approach may yield greater long-term benefits for those with a complex financial picture. You can optimize your financial strategy by carefully considering factors such as investment potential, tax implications, and financial goals.
For personalized financial planning tailored to your situation, contact our team at Qopia Financial. We’ve helped our clients create robust strategies to empower their financial well-being, and we’re excited to do the same for you.
