Lump Sum Or Extra Payments
But the real key to paying off your mortgage debt faster is to get a mortgage that allows you to make extra payments. Most mortgages allow borrowers to make annual prepayments of 10% to 20% of principal, without extra fees. These extra payments go directly towards paying down the principal. If possible, try to avoid a mortgage that only allows you to make extra or lump sum payments on the mortgage anniversaryas this can reduce the likelihood of making the extra payment.
The Difference Between Investing In Your Retirement Vs The Stock Market
Investing directly in the stock market isnt your only option. You might also choose to put extra money into your retirement account a 401 or a Roth IRA, for example.
Retirement accounts have numerous benefits when compared to a more traditional stock market investment. Both a 401 and Roth IRA have tax advantages. With a 401, you can set aside money from your paycheck before taxes, and you wont pay taxes on the investment or its gains until you take the money out. With a Roth IRA, you invest money after taxes, but you wont pay taxes on the money you take out in retirement.
Keep in mind that both types of retirement accounts have limits on the amount of money you can contribute each year.
The decision is up to you, and theres no one right answer. If your goal is to save more money for retirement, putting money in a retirement account may be better. If your goal is to have extra money available more quickly, a stock market investment may be preferable. If youve already reached your contribution limits on your retirement account, then a stock market investment is likely the way to go.
Your Return Rate Should Be Higher Than Your Home Loan Rate
You should also think about other costs and income of any investment, including the tax benefits or costs. For example earnings from investment property, shares and managed funds are subject to income tax. You may also have to pay capital gains tax if you sell them for more than you bought them for.
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Cash Flow Gain Under Scenario A
- Capital gain from the house. This is the difference between the house price at the end of the loan period and the monies paid to the bank as well as the down payment for the house. Refer to section 2.
- Gain from investing in the stock market. This covers both the capital gain from the increase in the stock market index and the dividends received. Refer to section 3.
Which Goal Is More Important
When it comes to deciding Should I pay my mortgage or should I invest? the first point you need to consider is Which goal is more important?.
We realise that for some people they just want peace of mind and being mortgage free will certainly help to achieve that.
Theres no denying that paying off your home loan quickly will help reduce the total amount you spend on interest, but its not necessarily a bad thing to maintain your mortgage for its full term if you put those additional funds to good use.
If you are determined to accumulate wealth and secure your financial future, it might be worthwhile doing some number crunching. Investing the money you would have utilised as additional repayments could make a significant difference to your overall financial position.
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For Most Americans Including Taxes Favors Paying Down Mortgages
Our initial analysis above doesn’t factor in the impact of taxes. A common argument about this type of analysis is the different tax treatment of stock returns and mortgage interest. Usually, you get more benefit from stocks, due to a lower tax rate for stock gains. However, recent changes in the tax code actually give an edge to the 30-year fixed for many Americans.
The Tax Cuts and Jobs Act of 2017 reduced the use of itemized deductions, such as mortgage interest, because the standard deduction increased. Now, 82% of homeowners have standard deductions large enough that the mortgage interest deduction isnt providing a tax benefit to them. Those who do benefit from deducting mortgage interest have a tax bracket of 24%.
Stocks held longer than a year are subject to long-term capital gains taxes, which, for the majority of Americans, is 15%. Heres how this might work out. Say that both mortgages and stocks have a rate of return of 10%. Tax affecting the mortgage rate at 24% would create a rate of return of 7.6% while the comparable stock return tax affected at 15% would be 8.5%.
5-YEAR S& P 500 RETURNS VERSUS 30-YEAR FIXED RATES
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Shop For The Best Rate
Quite often, then, buyers will stick with banks or financial institutions they already know and have accounts with. But when shopping for the best mortgage rate, its actually better to cast your net wide and far. Consider outside-of-the box lenders, including credit unions and mono-lenders , as quite often these institutions can offer much better rates and terms than big banks.
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Investing In The Market
If a homeowner is considering paying off their mortgage early, it might be worth considering whether some or all of those funds would be better off invested in the financial markets. The rate of return earned from investing might exceed the interest paid on the mortgage for the final 10 years of the loan.
In other words, the opportunity costmeaning the foregone interest that could be earned in the marketshould be considered. However, many factors go into evaluating an investment, including the expected return and the risk associated with the investment.
The table below shows how much could be earned on $100,000 if invested for ten years based on four different average rates of return: 2%, 5%, 7%, and 10%.
|How Much $100,000 Can Potentially Earn in 10 Years|
The above investment gains were compounded, meaning interest was earned on the interest and no money was withdrawn during the 10-year period.
Current Mortgage Rate Levels
Now, lets pause and go back to the current level of mortgage rates. As I mentioned, in Canada, you can currently get 7-year or 10-year fixed closed rate mortgages below 3%. I cannot stress enough how low that is. You might be too young to realize how high the rates once were, but people in their 50s or 60s surely remember the 15% interest rates in the early 80s. Therefore, if you can renegotiate and lock-in your rate at 3% or lower, you should do so right now. I cannot predict the future, and it is possible that rates continue to fall, but, there is a much greater chance that the rates will rise.
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Cash Flow Gain Under Scenario B
- Capital gain from the house as per Section 4. This is likely to be more than under Scenario A as you have paid less to the bank.
- Gain from investing in the stock market. You may argue that if you are using the extra money to repay the bank, where would you have the money to invest in the stock market?
Consider Your Tolerance For Risk
You need to know your own comfort level when it comes to the risks involved with homeownership and investing. Heres how the two options generally differ in terms of risk:
- Homeownership: In general, homeownership is considered less risky than stocks and other investments, since real estate often appreciates steadily over time. However, you also run the risk of having to sell in a down market, and you could still lose money if property values in your area drop.
- Investments: Stocks and other investments tend to be riskier investments because prices can be more volatile, with more frequent market crashes. If you have a higher risk tolerance, though, stocks typically rise in value faster than real estate.
Good to know:
On the other hand, the S& P 500 saw an annualized return of 13.84%, including dividends, over the past decade, from July 2010 to July 2020, according to The Wall Street Journal.
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Putting $1000 Toward Your Mortgage Vs Investing It
Lets run through a couple of scenarios showing what might happen should you put an extra $1,000 toward your mortgage or the stock market.
Say your mortgage balance is $200,000 with an APR of 3.25%, and you have a monthly principal and interest payment of about $870. If you put an extra $1,000 toward your mortgage each month, you could pay off your home in 10 years and six months and save $77,300 in interest.
But if you invested that $1,000 in a fund tracking the S& P 500 index, youd likely see a far greater return. Assuming a 10% annual return, youd end up with $191,249 in the same time frame. Thats more than double the amount you would have saved on interest had you decided to put that money toward your mortgage.
Credible is not an investment advisor, so be sure to speak with an investment specialist beforehand to see if the numbers work for you.
Pay Off Mortgage Or Invest Make The Right Decision With Windes
Investment is the clear winner according to math and logic. However, the true answer to the question Is it better to pay off the mortgage or invest? depends on the individual circumstances of the homeowners.
For example, cautious investors with a low tax bracket and high mortgage interest rate are better off paying their mortgage early. On the other hand, investing is a better option for risk-takers with a cheap 30-year fixed mortgage interest rate and a high tax bracket. Other factors like age, temperament towards financial risk, and financial planning also come into play.
It is advisable to consult with financial advisors and your accountant to make the right decision. Windes can help. Connect with us today to further explore these alternatives.
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Best Of Both Worlds: Refinance And Invest
If youre still on the fence about which option is best, you may not need to choose between paying your mortgage early and investing. Rather, you can take a two-pronged approach to reducing your debt and growing your wealth.
Mortgage rates are at historic lows, which means its a great time to refinance. If you took out your mortgage or last refinanced years ago, its likely that you can save quite a bit of money by refinancing to a lower interest rate and/or reducing your mortgage term length. Thats true whether or not you also choose to pay down the loan more aggressively. Just be sure to factor in closing costs when running the numbers.
With your newfound mortgage savings in place, you can go ahead and invest, too. This allows you to spend less on your mortgage overall while still taking advantage of the higher returns of the stock market.
Is It Better To Pay Off Your Mortgage Or Invest At Retirement
When preparing to retire, one question that is on most peoples minds is, Is it better to pay off my mortgage or invest at retirement? A common financial goal for many people is to retire debt-free, but most people approaching retirement are still paying off their mortgage.
Before you do anything, its important to evaluate your financial situation, available options, and opportunity costs.
Paying off a mortgage early can provide invaluable peace of mind and improve your cash flow. However, you might get a better return on your money by investing in the stock market, your business, or real estate while enjoying tax benefits from your mortgage.
So whats best? Lets examine the costs and benefits of paying off your mortgage versus investing at retirement.
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Pay Off The Mortgage Or Invest
Craigs Investment Partners
Should I pay off the mortgage faster, or use any spare money to invest? Thats a question we get a lot.
According to the textbook, the best approach is to pay off the mortgage as quickly as you can, before worrying about starting on your investing journey.
The floating mortgage rate is about 4.4 per cent at the moment, so if you make additional payments on your mortgage, thats essentially the annual return youre getting on that money.
Your other options for putting those funds to work will give you a varying range of returns. Term deposits are a very low risk option at around 1-2 per cent, depending on the timeframe, while managed funds, property and shares will deliver much more than this, albeit with a higher risk profile.
As an example, New Zealand shares have delivered an annual return of 10.6 per cent over the past 20 years, although this hasnt always been plain sailing.
The market has had numerous ups and downs along the way, including a couple of big declines. The most notable ones are the GFC, when the NZX 50 index fell 44.2 per cent, and then last year in the wake of the COVID-19 pandemic, when it declined 29.6 percent.
As it always does, the market has recovered from these periods and moved on to new highs.
In contrast, the return one gets from paying down their mortgage is risk free. Whether youre paying the floating rate of 4.4 per cent, or something higher or lower, youre guaranteed to have saved yourself that interest.
How Comfortable Are You With Risk
For many homeowners, it comes down to tolerance for risk. Chipping away at your mortgage is traditionally a safer move. Its predictable and youll know just how much youre saving. On the other hand, while the average annual rate of return for stocks is 8%,1 markets do fluctuate. Theres always some risk with investing, and the appetite for uncertainty tends to decrease as people focus more on saving for retirement. Consider your comfort level and how conservative you want to be.2
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When Paying Off A Mortgage Is Better Than Investing
I recently received a large sum of unexpected cash. An investment I had made a few years ago suddenly cashed out. When this situation comes up on social media it sparks a debate as to what to do with the money. Usually only two options are discussed: Invest the money or pay off debt.
As I thought about what to do with my windfall, there was only one clear answer that lit up like a neon sign pay off a mortgage. Those discussing this issue often only compare the interest rate of the potential options, which sounds something like this: You would have to be bad at math to pay off a low interest loan when you could invest the money for a higher return.
Unfortunately, this tunnel vision is costing people a lot of money. It is usually those who are only thinking about the difference in interest as a return on investment or some other parameter they feel is of the upmost importance. They neglect the current and actual effects of the decision. When I looked at the actual effect on my life, paying off the debt won hands down and here is why.
The loan I was looking to pay off was an owner carry mortgage I negotiated back in 2006 when I purchased a small apartment complex with no money down and owner financing. The terms of the loan included an option to pay interest only for as long as I wanted and the loan had to be paid in full in 30 years, which would be in 2036.
There were multiple options I could have chosen to use my cash windfall:
1: Pay off the mortgage
Pay Off Mortgage Or Invest: What Should You Do
Both options can help improve your finances, but there are certain factors such as risk and liquidity that you need to consider.
Edited byChris JenningsUpdated February 8, 2022
Our goal is to give you the tools and confidence you need to improve your finances. Although we receive compensation from our partner lenders, whom we will always identify, all opinions are our own. Credible Operations, Inc. NMLS # 1681276, is referred to here as “Credible.”
When you end up with extra cash, whether its through a windfall or an adjustment to your monthly budget, figuring out how to put that money to best use can feel like a daunting task.
One decision you might be contemplating is whether to pay off your mortgage with the new money or invest it. While neither option is a poor financial choice, there are benefits and drawbacks to both.
Heres what you should consider when deciding between paying off your mortgage or investing:
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Look Into Mortgage Recasting
A mortgage recast is when a lender recalculates a new loan balance and puts forth a new payment schedule, usually after the borrower makes a large payment toward the loans principal balance.
This new payment or amortization schedule will detail principal and interest percentages in each payment due from that point until the loan is scheduled to be paid off.
Since the new loan balance is naturally lower, a mortgage recast results in lower monthly payments for the borrower.
That all depends on your financial goals. But if you’re looking to save money, then an early mortgage repayment can be a smart move. Not having to pay interest for even one year will make a considerable difference. That said, your lender may charge you a prepayment penalty.
These aren’t necessarily dealbreakers, but do your research and consult a financial planner to determine if paying your mortgage off early is the best move for you.