Should I pay down my mortgage or invest the money?

With interest rates being at historic lows for the past several years, clients have been wondering, “should I pay down my mortgage or would it make more sense to invest the money?” While both options have their own unique benefits, the bottom line is either course of action can put you in a better position towards financial independence.   However, it’s important to note that before you consider either option, you’ll want to have your fundamentals in place. This includes having an emergency fund established (typically 3 to 6 months of fixed expenses), having life insurance in place to replace your and your spouse’s income in the event of an untimely death, and saving for retirement (ideally 15% of your pre-tax income). Once your fundamentals have been established, it then makes sense to explore the two options to determine which one makes sense for you.

Paying down the mortgage: Using excess funds to pay down the mortgage provides you with 1) the ability to be free from a mortgage payment sooner and 2) paying less money for the overall loan.

Let’s see how this works with a numerical example. Let’s say that you have a 30 year loan for $550,000 at 3.75%. In this case, your monthly payment is about $2,550 per month. If you were to put an additional $650 per month away towards your mortgage (making your monthly payment $3,200), your loan would be paid off in a little more than 20 years. In addition, the total amount of money that you would pay for your loan would be slightly more than $780,000 (over 20 years) rather than $920,000 (over 30 years), ultimately saving you $140,000. But did this really make you better off financially?

Investing the money: Let’s use the same numerical example as above, but instead of applying that $650 per month to pay down the mortgage, you had invested that $650 instead. Because we are now investing this $650 each month rather than paying down the mortgage, the house will be paid off in 30 years (which means the total payments would be $920,000). Had that $650 per month earned 6% a year, your total balance at the end of 30 years would be over $655,000!

What if you were to pay off the mortgage first (in 20 years), and then direct that same monthly payment towards savings? If your $3,200 per month earned the same 6% a year (for the remaining 10 years), your account would be close to $510,000.

While we do see a difference with the money earning 6% in both scenarios, we see an even larger difference in favor of investing the money if it were to earn 8% a year – the total value for investing the money for 30 years is $960,000, whereas paying off the mortgage in 20 years and then investing for 10 years is $570,000. Why is there such a big difference in values between 8% and 6%? It’s because had you invested the money from the beginning, you had time on your side to grow it (30 years with investing the money vs. 10 years after paying off the mortgage).

In the end, which is the best way to go? Unfortunately, the answer is, it depends. If you have a high interest rate on your loan, it may make more financial sense to pay down your mortgage. The only way to know which option is best for you is to calculate the numbers and run scenarios with some assumptions to give yourself the ability to make an informed decision. For help, please feel free to contact me via email or give me a call.