Many homeowners have a strong desire to pay off their mortgage as soon as possible. After all, it can sound amazing to live without the heavy burden of a high mortgage payment hanging over your head each month.
However, when you think about throwing so much money toward a debt, you understandably may wonder is it better to pay off a mortgage or invest the money in a more lucrative investment option. While you may think that there would be a straightforward answer, the real answer is rather complex and requires greater analysis on a case by case basis.
Examining Possible Investment Options
Before you throw all of your extra money toward investment loan repayments or a home mortgage elimination plan, you should understand what the possible investment alternatives are. There are several investments that pay off substantially. For example, you may expect an eight to 12 percent annual return on your investment in the stock market over the years. Real estate investments may be even more lucrative.
Given the fact that your mortgage interest rate may be between three and five percent if you obtained the loan within the last few years, it may seemingly be a no-brainer to invest the funds into a higher-yield investment option. However, there are several other factors at play that you need to analyze as well.
Understanding the Risks Associated With Investments
If you were guaranteed a sizable return on your investment, you may wholeheartedly invest your money rather than pay off a low-interest rate debt that generates tax deductible interest. However, most investments come with risks, and investment income is taxable. For example, your funds in the stock market could decline in value, or your real estate investment’s property value may plummet.
Furthermore, the income on these investments is taxable, so the return may not be quite as advantageous as you might initially think. The safest alternative for your money is to put it in a no-risk savings account, but the return on this type of investment is substantially lower than the interest you will pay on your mortgage loan. Nonetheless, many savvy investors are able to earn a greater return on their money than the three to five percent rate their mortgage has while taking only a moderate risk.
Reviewing Your Future Plans
When you ask is it better to pay off a mortgage or invest the funds, you also need to focus significantly on your future plans. For example, if part of your retirement plan includes your home being paid off free and clear within 10 years, you understandably need to have the mortgage paid by that time.
However, if you only need to use some of the equity in an expensive house to pay for a more affordable condo outright in retirement, you may not necessarily need your mortgage entirely paid off. This is even truer if it is more important for your future plans to have a fully-funded investment portfolio that produces substantial income that you can rely on in your retirement years.
Therefore, the amount of equity in your home currently as well as a number of funds in your investment accounts at this time may also play a role in your important financial decision.
Using Online Calculators
Investments have the ability to compound over time through compounded interest and dividend reinvestments. This means that investing more money in your investment accounts as early as possible can pay off richly in many cases. On the other hand, mortgages are amortized, and this means that the amount of interest you pay on the loan is substantially higher in the earlier years of the loan. This is more significant when you have a long-term loan.
In order to determine which option is most beneficial to you, you can easily use an online loan repayment calculator and a future value of investments calculator. Run through different scenarios to see which option is more lucrative to you over the long run.
Analyzing How Time Plays a Role in Your Decision
As you might imagine, the factor of time is an important aspect that you must carefully consider as well. For example, if you have a very low-interest rate and you recently started a 30-year mortgage in your 20s, investing your funds in investments that pay off lucratively is a great idea. This is because you may be able to generate an 11 or 15 percent return on your funds year in and year out for decades before you retire.
On the other hand, if you are in your late 50s, the effects of compounded investment returns on your portfolio will be less significant. More than that, because you are close to retirement, you may not be willing to make such risky investments. You may prefer to put your funds in CDs and bonds that generate a nominal return for you. With this in mind, you can see that there is no clear-cut answer that is best for every situation. More than that, if you are in your late 30s or early 40s, your confusion over this matter can be significant.
If you are like most homeowners, you may still owe $100,000 or even several hundred thousand dollars on your home mortgage. You may also have investment real estate loans that you are thinking about paying off. The decision about what to do with so much capital over the course of several years is not a matter to take lightly.
While there may be benefits associated with paying off one or more mortgages, these also may be advantages to investing the funds. As you can see, there is not a catch-all answer to the question of is it better to pay off a mortgage or invest. Instead, each homeowner will need to carefully analyze the situation as it pertains to them.
Make use of online calculators, and understand the types of investments that you would feel most comfortable investing in. By looking closely at all relevant factors, you can determine the best course of action to take with your funds.