Should I invest or put extra money toward my mortgage to pay it off early?
I bought a house three years ago with a 3.875 percent interest rate. Over the last year I have become serious about budgeting, saving, and cutting expenses. I'm in a position where I think I could pay off my mortgage in five to six years, which should save me $60,000-$75,000 in interest. This would require me basically doubling my mortgage payment and putting most of my bonuses towards principal each year. I would also be completely debt free after paying it off. However, I'm 35 years and one of my main advantages for growing wealth is time.
Does it make more sense to pay off the mortgage in five years, or strive for a seven to ten year payoff window, while also using part of my income and bonuses to invest in real estate and the market and letting that compound over time?
Great question, and kudos to you for being serious about budgeting, reducing debt, and investing in your future. You have a low rate on your mortgage, and not having a mortgage is certainly a great goal . I would fill up other buckets before making extra payments on your mortgage, however.
1. Emergency savings (guessing you have this one covered)
2. 401(k) savings to maximize employer match
3. Payments on high interest loans charging over 6% interest (doesn't sound like an issue for you)
4. Contributing to an HSA if eligible
5. 401(k) savings up to the maximum contribution of $18,500 per year. Given your age you may consider a Roth 401(k) if it's available.
6. Additional payments on low interest loans like your mortgage.
7. IRA or Roth IRA contributions if eligible
8. Taxable accounts
Again, you're doing great in making this a focus so early in your life. Hopefully this list can provide you some guidance on where extra cash should go. Not that you would have done this, but I have seen young professionals make a great effort to pay off their mortgage only to turn around and decide they can now afford a bigger house. Now they have a mortgage again and still haven't made retirement savings a priority. It sounds like you have your stuff together, but this is a trap that people have fallen into.
Hope that helps, please let me know if you have further questions.
Matt Ahrens, CIMA®
This is a question that many are asking. There are actually two schools of thought on this, so I'll briefly explain both and then share what I advise my clients to do.
If you want to address the question from a purely mathematical standpoint, and your mortgage has a low fixed rate, then simple math dictates that investing for the long term will most likely win. This is because investment appreciation is out-pacing the low mortgage rates of today's market. In other words, you stand to gain more return in the market than you will pay in interest on your mortgage, so your money would be more efficiently used to invest.
The other option is paying down your mortgage debt first, which gives you a very measurable goal and avoids the risk that inevitably comes with investing. Every dollar that you put towards reducing your mortgage principal is a guaranteed rate that you don't have to pay interest on. The rationale is that by paying off your mortgage, you are significantly increasing your monthly cash flow. And many people link retirement goals to when their mortgage will be paid off. They assume that in retirement they will downsize, sell their home, and use the equity to supplement their income. In reality, most people actually decide to keep their home or downsize in square footage but NOT in their mortgage amount.
So here's what I like to remind folks of:
1. Only about 70% of the cost associated with your home is actually principal and interest. The other 30% is taxes, insurance, and upkeep. Even if you pay off your mortgage completely, you're still going to be left with that 30%. So, yes, paying off your mortgage will free up some monthly cash, but given the fixed costs of owning a home, it may not be as much as you think.
2. You can't spend the money that's tied up in your house. Once you pay off your mortgage, the only way to get access to the equity is to borrow again or sell your home. So let's say you're finally ready to tackle the remodel you've been dreaming of; chances are, you're going to end up with some sort of mortgage again. That just begs the question: what was the point of foregoing the investment appreciation to pay down your debt if you were just going to walk back into debt down the road anyway?
I do acknowledge that there is an emotional human connection to answering this question. As with many financial considerations, decisions aren't always based on math. It has been my experience that paying down a mortgage -- regardless of how the math works out -- makes people feel more secure. The emotional benefit of your mortgage decreasing right before your eyes in black and white every month has a value that can't be measured in dollars and cents. It just feels good! You get to see the numbers reflecting that you are steadily on your way to achieving your goal, and that's a win.
On the other hand, investing for the long-term is somewhat intangible. After all, even though you get to enjoy the market that brings you a steadily increasing portfolio, you also have to endure the market that's declining. In fact, that's the very nature of investing for the long haul. You may know it's the right thing to do, but it just doesn't feel as good as the steady climb towards your goal as with paying down a mortgage. It's like enduring both the incoming and outgoing tide regardless of which way you're heading. You'll eventually reach your destination, but it sure does feel better when the tide is pushing you along as opposed to moving against you.
What do I advise my clients to do? Typically, it's a bit of both. First, I say to take advantage of proven market growth and invest for the long-term. Then, when you have extra cash, whether from monthly cash flow or perhaps a bonus, allocate at least some of those dollars toward reducing your mortgage debt.
Keep in mind that there are highly individual nuances in each person's scenario, including your tax rate, your investment allocation, and the amount you're saving. Any of those can impact the way you might allocate your money. One of the advantages of working with a professional is that we have the tools and knowledge to answer this sort of question specifically and accurately just for you.
While paying off a mortgage is a massive psychological benefit, it won't help you build wealth as fast as focusing on multiple goals at the same time. While paying down a mortgage could save you six figures in interest expenses, it could cost you seven figures in lost retirement investment opportunity. I wrote an article on the math behind why focusing exclusively on paying off debt early is actually financially risky. Although the article is regarding student loan debt, the numbers and principles would be the same for paying off the mortgage early.
In summary, here is what the math shows:
- Exclusively paying down the mortgage will leave you with less net worth (assets minus loans) on the date the mortgage is paid off verses balancing between mortgage repayment, retirement investing, and other savings goals.
- For a 25-year old, focusing on paying off a $50,000 debt at 4.45% APR will cost the person nearly 3/4 of a million dollars in their retirement account balance at retirement.
- Exclusively focusing on paying off the mortgage early actually increases the risk of losing the house to a job loss due to less liquid savings balances. The risk of course would disappear in five to six years.
If you still want to pay the mortgage off early, a better option would be to invest the money in an appropriate portfolio based on a 5- to 6-year investment horizon, while also funding retirement based on a calculation of your needed retirement contribution level. Any fee-only and fiduciary financial advisor should be able to help you calculate both objectives. Then, once you've built up enough in your non-retirement account to pay off the mortgage, simply write the check and pay the entire mortgage off in one month.
Dear should I invest or put extra money toward my mortgage to pay it off early?
I applaud you at 35 years old for being "in control of your financial journey".
As you say, "I'm 35 years and one of my main advantages for growing wealth is time". You are right, at 35, you have lots of time. If you take advantage of it wisely you are blessed. I believe listening so far you already are. The interest rate on the mortgage is 3.875. The interest rate on any one ETF comprised of S&P 500 select stock has an annualized return of approximately 10%. In the end, the decision you make will be your own. Combined with education about the markets, the empowerment about various techniques of investing, at the end of the day it is best for you to say "i did this because I believe this was the best approach for me".
Because believe you can pay off the mortgage in five to six years saving $60,000 to $75,000 annually in interest fees, just do it. You sound determined to be debt free. You alone have budgeted and saved successfully accomplishing a goal wished for by many but only accomplished by few due to the focus and dedication required to make this happen. Bravo to you! Make any and all of your financial selections clearly with your goals, selections and time line in mind. This will be gratifying, this is your own best win. Selectively dividing payments into real estate and investment accounts with a seven to ten year window for the pay off of the house will grant you a greater return over the long run.
Conversely, I am someone who loves to accomplish goals one at a time to completion. The immense feeling of being debt free is outstanding. You will say and it will be true, you accomplished this goal totally on your own. The excitement of paying off the house saving $75,000 in interest sounds fabulous. It is your ultimate choice. The "prize" of financial independence will provide you with countless benefits that will become apparent in time. You are in control, you will forever determine your day to day not a bank nor interest charged on loans or fees for debt. Five to six years of solid focus is not a long time neither is seven to ten years. Both time frames are manageable and doable. Commit to this task starting today and make it happen. I cannot wait for the email that says you are debt free, focused and grounded to save and invest more!
At 35, whatever your choice, you have so many years ahead to diversify into select Mutual Funds, ETFS, Index Funds that over time will compound the value of your long term holdings. Not only will you be debt free, you will be grounded in knowing you are in control, you have built an estate for future self and generations. You mapped out a financial roadmap that spells success. Continue this positive tragectory to achieve financial independence by ridding yourself of loans one at a time going forward keep this mindset. Start by paying down the loan with the largest interest rate which for you at this point is a house loan at 3.875%. Your gut will tell you which choice is the best choice for you.
You have set the stage for a fine financial future. Plan to open IRA and 401K accounts.
A LIFE OF INVESTING
Whatever investment funds you create; long term funds with value and growth strategies or short term strategies with individual stock selections, a mindset of saving is key toward the attainment of financial independence. CD or Money Market accounts for a 35 year old are safe but will not yield returns you demand.
Your course of action at 35 years old is to carefully and cautiously choose a seasoned financial mentor, dare to seek knowledge, to plan, to read, learn and patiently construct a wealth plan of action which involves focus, commitment and dedication over time to the very best and most promising funds and individual stock selections. You must be comfortable with the plan. You must personally know and acknowledge the plan and not leave the plan to someone else. Because you are 35, time is on your side. Today, $10,000 invested in a high yielding ETF, Index and or Mutual Fund compound over thirty to fourty years will get you higher interest rate accrual than you would yield in a CD account by far. For an Index Account or ETF based on the S&P Sector the average annualized return over a ten year period is approximately 10% annualized. For a CD account or money market account far less. Again, what ever choice you make must be your own. You are blessed with lots of time on your side so do your home work and invest for yield. You may see market fluxuations over time but remember that all good stocks fluxuate, a natural phenomenon.
You have what it takes to reach financial indenpendence.
BE FINANCIALLY SAFE FOR EMERGENCIES
Before you max out a strategy to become financially independent and save utilizing the IRA and the 401K accounts there are manditory steps to be taken to get you mentally, educationally and responsibly ready. Develope a financial conscious mindset. Develop this mind set and be sturdy and firm in this quest.
An emergency fund will save you in case of emergencies; events unexpected, necessary and urgent expenses though events that must be planned for regardless. Differentiate this fund from any and all cost of living expenses. An emergency fund is separate from a source of money to save for a home, money for school, money for food and clothing. Such money must be allocated for emergencies only; things that happen in life, not expected but they happen unfortunately; sudden loss of income, sudden illness, something you must do for a family member or friend, a tragedy or disaster does happen. Unfortunate, No one else is going to plan for your emergencies but you.
35 is wonderfully young!, this is the perfect time to plan, save and pattern behavior. Formulate a mindset today, think about saving, investing, budgeting, emergency planning and long term budgeting which will include an emergency fund (inquisitive & focused mindset required). Force yourself now to visualize the long term. Start now to compete with yourself to create an expectation long term.
Make your Financial Plan visual. Write your plan on paper. Dedicate yourself to amass a one year safety net of funds. This long term process will result in a design involving trust to create a purpose of financial security about money and what it is worth long term for your future. Dedicate yourself to have conversation(s), gain understanding of a strategy to save long term for emergencies. This mind set of mental strength should be strengthened now and ongoing into the future. Learn the financial mindsets of those you share time with make certain you collaborate with like minded individuals so that your plan is strengthened and the focus maintained. A financially fit lifestyle will make a difference in your lifestyle.
Emergency money is not to be utilized whimsically, not "easily accessible". Safety and security is key. Place funds in an account not utilzed by you on a regular basis. If and when the time comes you marry, you must share immense trust, total belief and an oath of confidence to keep monies safe no matter what purchase either one of you "has to have". This oath is key for marital success.
Communication about funding emergencies, consistent discussions regarding your plans for Financial Independence and funding for emergencies must start now and continue through life. The Quantity of funds in an Emergency Fund should be equal to one year income. The amount of funds can vary however it is always best to have in reality more than less money available to you. Place funds in a simple checking or money market account. Money in either of these types of accounts will be free to remove funds quickly and easily versus accounts incurring a tax consequence if withdrawn early.
A first creative strategy to form an emergency fund is to be creative; develop strategies to form an emergency investment fund to include ways for you to work on projects, tasks you otherwise would have farmed out to other people. Sample tasks (cleaning house or washing cars) save money allowing the emergency fund to grow.
A second creative strategy is to perform side hustles (Uber, dog walking, caring for children, a barista at Starbucks). Opportunities are out there, pick a passion, make money, translate into a stream of income or an entrepreneurial ability you did not think possible. Make it fun, entrepreneurial, present tense!
A third strategy is to sell things clutter in your life. Be free from encumbrances. Make a strategy, a game.
See what you can do to rid yourself of clothes, books, belongings, make this an adventure. With the removal of items that were taking up space in your precious life comes time to think of other ways to be creative.
A forth strategy is budget, budget and budget. Youth are forming FI groups (Financial Independence). They are collectively and individually becoming frugal, more aware, vowing to get rid of debt, live simply, on a crusade to become free from expenses, free from debt. This takes discipline, mind control. In the end, great values about money are established, a life of freedom and control, a life knowing you have your emergencies covered.
PEACE OF MIND
Whatever strategy you take, the process of frugality and long term money management and control though difficult will assist you to gain greater peace of mind with each and every amount of money you are able to put away.
I stopped Starbucks and an expensive health club membership. I thought I needed both of these things, I was initially crushed to get rid of the expense. Now, after months, I do not miss these things. I replaced spending "habits" with an ability to save $1000 or more each and every month to put to savings. My partner's desire to save and not spend was actually what I needed. I wish we had spoken about money openly. Be open to change, be open to talk about money!
Be patient on the purchase of a home. Start your homework now but do not rush to purchase another property. Be diligent and deliberate. It sounds as if you already are.
All the very best to you,
Jan Attard, MBA, RIA
J. Oliver Maxwell, LLC
We would love to be able to help you! However, to get started on the right foot, we have many ?’s to ask you first. We work very much like a doctor would. Keep in mind you just don’t walk into the Doc’s office and immediately get a prescription.
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There are far better ways to growth Weath and Keep it TAX FREE than using your own home. Are you self employed? Why do you want to pay off your home? Consider keeping the tax deduction and invest money in the market for a better return. Either way, no way to strip the equity out of your home, unless you refi or sell....
Brett M. Sause, LUTCF®, LTCP®, CLTC®, RFC®, LACP®, FSCP®
Principal & CEO