Invest or Pay Off Your Mortgage?
How to Decide
Should you invest extra cash or use it to pay off your mortgage?
It’s a heated debate that rivals French press versus pour-over coffee and “Star Wars” or “Star Trek.” But while all three topics might get passionate believers on both sides all worked up, investing or paying off your mortgage is a choice with serious financial consequences.
Here’s how to know which way to go.
The six variables to consider
To decide between the two, Justin Goodbread, a certified financial planner in Knoxville, Tennessee, suggests you consider six variables:
1. Your home’s current market value
2. Your mortgage interest rate
3. Home appreciation in your area
4. Your income tax rate
5. Expectations for inflation
6. An assumed rate of investment return
In an analysis on his blog, Financially Simple, Goodbread used national averages for these six parameters to compare different scenarios between investing and paying off a home loan early.
The math on each of these what-ifs favored investing over paying off a mortgage.
But, of course, Goodbread says the real answer to the question “Invest or pay off your mortgage?” depends on your situation. When pressed for a rule of thumb, he offered two:
Pay off your mortgage early if:
You’re a conservative investor, in a low tax bracket with a high mortgage interest rate
INVEST IF:
You’re an aggressive investor, in a high tax bracket with a low, 30-year, fixed mortgage interest rate
You’re younger than 50
MORE: The pros and cons of home equity lines of credit
Understanding Home Equity Lines of Credit
The home equity line of credit, or HELOC, is also known as a “second mortgage.” Because your home is often your most valuable asset, you use it as collateral for another loan.
The downside is that if you can’t pay back the HELOC, the lender may force you to sell your home.
What is a home equity line of credit?
A home equity line of credit gives you access to a sizable pool of cash, usually up to about 85% of your home’s value, less the balance remaining on your mortgage and adjusted based on your creditwortthiness and ability to pay.
How a HELOC works
Say you have a $500,000 home with a balance of $300,000 on your first mortgage and your lender is allowing you to access up to 85% of your home’s equity:
$500,000 x 85% = $425,000
$425,000 – $300,000 = $125,000, your maximum line of credit limit
Keep in mind that most HELOCs have variable interest rates. This means that as baseline interest rates go up or down, so too will your interest rate.
To set your rate, the lender will start with an index rate, like the prime rate or LIBOR (a benchmark rate used by many banks), then add a markup depending on your credit profile. Variable rates leave you vulnerable to rising interest rates, so be sure to take this into account.
5 reasons to keep your mortgage
According to Goodbread and Ric Edelman, founder of Edelman Financial Services in Philadelphia, the primary reasons for carrying a mortgage — and not accelerating payments on the principal — include:
1. Homeowners need to maintain liquidity. If you have a financial emergency, cash reserves are essential. Homeowners who pour every dime into paying off their mortgage early might not have a cash cushion. You’ve essentially “buried the money in the walls of the house,” Edelman says.
2. A mortgage doesn’t affect a home’s value. “The house itself doesn’t care if it has debt on it or not,” Goodbread says. Over the long term, it’s likely to appreciate regardless of the amount you owe on it, he adds.
3. Mortgage interest is inexpensive. Because the mortgage is secured by the value of the home, interest rates are much cheaper than for credit cards and personal loans — and the interest you pay is tax deductible. It’s likely the cheapest money you’ll ever borrow, Edelman says.
4. Mortgage payments get easier with time. They’re often a budget stretch for young homeowners, but with a 30-year fixed mortgage, time is on your side. As the effects of inflation and a growing income take hold, “that monthly payment gets easier and easier to make,” Edelman says.
5. Investments will outperform the interest cost of the mortgage over the long term. “That scares some people,” Edelman concedes, because of the stock market crash of 2008. However, he’s not advocating 100% stock investments, but rather a diversified mix of investments built for a 30-year time frame. That period matches the term of a fixed-interest rate mortgage.
“Wealth is created by investing,” Edelman says, not by paying down debt.
Considering ‘debt-free homeownership’
But what about noted author and radio host Dave Ramsey’s advocacy of debt-free homeownership?
“I’m right; he’s wrong!” Edelman laughs. He’s quick to add: “Dave and I are talking to two very different groups of people.”
Edelman says Ramsey often advises people who in the past “have demonstrated an inability or an unwillingness” to properly manage their personal finances, particularly debt.
“And Dave correctly recognizes that for these folks, credit is a drug,” Edelman says. For them, “abstinence is essential. And elimination of debt and avoidance of debt is necessary.”
But for homeowners who manage debt responsibly, “Getting a big, long mortgage and never paying it off is the smartest, safest strategy to use,” he says.
With one caveat:
“Many people buy homes they simply can’t afford,” Edelman says. He advises limiting your mortgage to a payment that is no more than 30% of your income, before taxes and deductions.
The article Invest or Pay Off Your Mortgage? How to Decide originally appeared on NerdWallet.
My Ideas:
If you are at the earning stage of your life, it is better to be diversified in the Stock Market and Real Estate Market.
Usually Real Estate is a safer investment, You have to live somewhere... it is financially more stable to pay your own mortgage rather than to pay rent! You should always check interest rates to be able to refinance and get lower interest and get out of a 30 year mortgage... The trick with a mortgage payment it try to stay with a 15 year mortgage or lower when refinancing... YOU PAY LESS INTEREST THAT WAY!!