Should I use my extra money each month to invest or pay towards the balance of my mortgage?
I have about $1,000 extra each month that I want to either invest or pay towards the principal of my mortgage ($81,000 with a 5.75 percent interest rate). What would be the best use of my money?
Less stress = longer happier life!
This is a good question and I am sure that answers you have received support more of the Math than that of behavior finance. Indeed you could invest in the market and historically get a better return. But there is no guarantee how well or poor you will fair.
From a behavior finance view point, I have found that having a free and clear home brings peace of mind. It gives you options to focus on the things that you value most which might not be work. You could rent the home and live abroad. You can take a sabbatical and not have to worry about having a roof over your head. Regardless, in less than 7 years you would be free and clear. Imagine how you will feel when you have $1000 plus your payment to use at your desire. That is all cashflow! And most importantly, much less stress.
Less stress = longer happier life!
What would you feel better about?
At the end of the day, being debt free feels good. Having less bills makes life easier. Also, there is great value in having a healthy investment and seeing it grow. Each of us have a different take on how we handle stress and how it affects our behavior. Historically, good investors stick to a good financial plan. Go with what you feel is best for your peace of mind.
For a good online calculator I suggest: Bankrate.com
This is a mortgage payoff calculator and it will tell you how many years you will save. I hope this helps you make an informed choice!
With love and regards,
Jose Sanchez, CFP®
First, is your mortgage variable or fixed? If variable, It would for sure make sense to allocate the extra $1,000 per month to your mortgage. We're in a rising interest rate environment and will likely only see rates go up from here for the foreseeable future. If fixed, the decision is a little harder. Obviously, you cant go wrong with working towards paying off debt. However, you may consider putting extra towards long term investments such as an IRA or Roth IRA. We know over extended market cycles, depending on the time period you measure from, the stock market can average anywhere between 8-10%, which is greater than your 5.75% on your mortgage. Maybe you consider, maxing out your IRA and then using the excess towards paying down the debt. You can never get back a year's worth of contributions to retirement accounts and the fact they're capped means its harder to play "catch up". The earlier you can put more funds into retirement accounts the better so you can take advantage of decades of compounding.
Again, it's a balancing act. You can't go wrong with accelerating your debt payments, especially at that interest rate. However, I wouldn't necessarily fault you for deciding to contribute some to a tax advantage retirement account.
I like the pay down your mortgage idea; it's a 5.75% rate of return on your money guaranteed -- no bank out there is offering that. However, if you don't have sufficient cash reserves on hand I'd probably do that too, maybe 50/50 or something that feels comfortable. Cash reserves are very important to have and justify giving up some of that 5.75% to have. If you are comparing the rates of return on investments vs your mortgage then keep in mind that you are effectively borrowing money to invest. Want to do that? It's leverage plain and simple and when think in those terms it means whatever investment you choose just got riskier.
If you already have a sufficient cash reserve and you do not need money for any major purchases, you should pay down your mortgage.
How much should your reserve fund be? One rule of thumb is 6 - 12 months of expenses. That would give you flexibility in case your employment situation changes. We usually lean toward six months if two people are employed. And, we lean toward 12 months if only one person is employed.
So, if your expenses are $4,000 per month and you and your spouse both are employed (somewhat equally compensated), your cash reserve should be about $24,000. ($4,000 X six months = $24,000).
Hope this helps!
You left out a critical piece of information, which is how many years of your mortgage are left and how many you started with. Interest is amortized, so that the early years of a mortgage are almost all interest and the final years are almost all principal. If you have 7 years left of a 30-year mortgage with a 5.75% interest rate then the effective interest rate is about 1%. The fewer the number of years left on your mortgage, the more it makes sense to not prepay it since you are essentially borrowing money on your house interest-free. Even a 2% bank CD or a 6-month U.S. Treasury paying 2.1% would make more sense as an investment than prepaying a mortgage with less than 1/4 of its lifespan remaining. On the other hand, if you have 28 or 29 years left of a 30-year mortgage then you probably should pay it off because your effective interest rate is near 10% for the next few years.