As you continue through your financial journey, you may be wondering if you should pay off your mortgage or invest. Depending on what stage of life you are in, you may be leaning one way or the other.
Understanding Your Mortgage
Before we make a decision, let’s take a deeper look into what we are paying for with a mortgage. A look at our interest rate, monthly payment, and the amount of time we are paying for a loan will determine how much we actually pay. I’m going to warn you, this post is math intensive, but I will wrap it all up in an easy to understand format at the end.
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For my readers out there, lets start from the top:
To begin, let’s look at a $200,000 loan. For an interest rate, let’s assume you have a great rate of 4% over a period of 30 years. With these figures, our mortgage will look like the following:
Mortgage = $200,000 at 4% for 30 years
Monthly Payment = $955 base – not including taxes, possible PMI, etc.
Total Paid After 30 Years = $343,739
So if we do not make any extra payments, we would have spent an extra $143,739 in interest to the bank for that loan.
First and foremost, not all investments are the same. I have described this more thoroughly in my related article: Exposing The Mutual Fund Industry For this example, let’s assume we decide to invest in an S&P Index Fund (great choice!). Historically, the S&P has averaged about 8% per year. With that being said, let’s do the following calculation based on compound interest.
Investment = $955 a month, for 30 years at 8% interest
Monthly Investment = $955 = $11,460 a year
Total Investment After 30 Years = $1,402,083.65
⊕Extra Money Towards Mortgage Scenario
Now, this is not apples to apples. The original question is if we should neglect retirement and pay off our mortgage first. Let’s dig further into this scenario. Let’s change the scenario and assume we plan to pay off our mortgage early. Assume we are able to pay our mortgage off in 15 years instead of 30.
Mortgage = $200,000 at 4% for 15 years
Monthly Payment = $1479 base – not including taxes, possible PMI, etc.
Total Paid After 15 Years = $266,288
After 15 years, we would have paid, $66,288 in interest to the bank.
Obviously paying down our mortgage quickly has an impressive impact on the amount of interest we pay to the bank. By cutting our mortgage time by half, we were able to pay $77,451 less in interest on our loan.
In this scenario, we increased our mortgage payment by $524 a month and cut 15 years off our loan. By doing this, we saved $77,451 in interest.
⊕Invest The Extra Instead Scenario
In the above scenario, we paid an extra $524 a month to save $77,451 over the life of the loan. What if we had invested that $524 a month for those 30 years instead of reducing our mortgage time? Let’s see how that impacts our investments.
Investment = $524 a month, for 30 years at 8% compound interest
Monthly Investment = $524 = $6,288 a year
Total Investment After 30 Years = $769,310.82 after 30 years
So if we did not pay extra on our mortgage, we would have paid an extra $77,451 in interest over the life of the loan. However, if we used that extra money to invest, we would have made $184,391.09 after the first 15 years. This amount would have compounded to $769.310.82 after the full 30 years.
⊕Apples To Apples
The final scenario involves us paying our mortgage off in 15 years and not contributing to retirement during that time. After the 15 years, we will invest the full $1,479 a month into retirement for 15 years to see where we end up. This is the true apples to apples test.
Investment = $1,479 a month, for 15 years at 8% compound interest
Monthly Investment = $1,479 = $17,748 a year
Total Investment After 15 Years = $520,447.38 after 15 years
⊕So Should You Pay Off Your Mortgage Or Invest?
1st Scenario = Delay retirement and pay off the mortgage early (15 Years) and then invest heavily for 15 years = $520,447.38
2nd Scenario = Payoff Mortgage in 30 years, and invest a smaller amount for 30 years = $769,310.82
The clear answer is to invest first. By delaying your retirement and focusing on your mortgage, you are giving up way more than you are gaining. By investing a smaller amount for a longer period of time, after the 30 year period, you would be up $248,863.44 versus delaying retirement. Compound interest is amazing and it works much better with time.
⊕The Best Answer!
Where does this all fit in? The best advice I can give you is this:
Phase 1 – Build A Budget – Budget Article Here (GET FREE BUDGET PRINTABLES HERE!)
Phase 2 – Save $1,500 – $2,000 for Emergencies
Phase 3 – Pay Off Your Debt (except mortgage) Debt Payoff Article Here
Phase 4 – Have Cash Reserves For 6 Months Of Expenses Side Hustle Article
⇒Phase 5 – Put 18% Of Your Income Into Retirement|Investments
Phase 6 – Save For Specific Plans (i.e. kids college, elderly parents etc.)
⇒Phase 7 – Pay Off Your Mortgage ASAP! Pay Off Mortgage Article
Phase 8 – Build Even MORE Wealth
⊕Wrapping It All Up
As you can see from the above strategy, due to the power of compound interest, retirement should be started before you pay extra towards your mortgage. Start that ball rolling on your retirement by setting yourself up at 18% of your income. By investing this amount, you are giving yourself a rock-solid retirement in just about any scenario.
You do not need to go crazy over the 18% if you still have a mortgage. If you are able to put the 18% away, put any extra money towards your mortgage to pay it off early! Win-win! There is certainly something to say for not having a mortgage payment. The security that comes from that is unmatched. It gives you the freedom to know that if you lost your job, you wouldn’t be kicked out to the streets. You would still be able to provide shelter for your family.
So to answer your question, you should invest first, up to 18%, and then pay off your mortgage early. By doing this, you will be able just about anything that life throws at you.
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