If you’re a homeowner you’ve probably wondered at some point if you should pay off your mortgage early or invest? Most Americans get a 30-year mortgage, but approximately 21 million Americans, or almost one in three, outright own their homes with no mortgage. Is that a smart move?
Brendan, a past student from Best Money Class Ever, (who paid off his car and credit card, over $8,000 within four months!) is now a homeowner, and he wrote in to Ask Carly to find out.
Ask Carly is a way for us to stay connected and support one another on our journey to gaining financial independence. You don’t need to figure this money stuff out on your own. You can submit your questions about life and money here.
Me and a coworker were discussing our houses, and I told him I was trying to pay it off in five years. He says he is only going to pay the minimum on his house due to his low locked-in interest rate of 4%. His view is, “Why overpay on a house when you can make 10% in the market? The S&P makes about 10% per year. It’s better to make money that way.”
By the way, if ya aren’t a homeowner yet, check out this post that goes over financial indicators that show you’re ready to buy a home.
Let’s geek out on finance and dive into the battle between paying off your mortgage debt versus investing.
First, here’s the assumptions we’ll make:
You’re a 30-year old with a $200,000 mortgage with 4% interest and you plan on retiring at the standard age of 65 with your investments earning 10%. Your mortgage payment is $955 including principle and interest (not including property taxes and insurance).
To pay off your mortgage in five years you’d get the job done by paying $2,750 extra each month.
We’ll assume you have an above average income with the disposable income to pay off your mortgage early and/or invest a large amount.
Now, Let’s Talk Mortgage Interest
Mortgages are amortized where you pay the same amount each month, but initially (for the first 20 years) the majority of what you’re paying goes towards interest versus the house itself.
Here’s how much you’ll spend in interest over the life of the loan:
- $72,147 in interest and $42,433 on the house in ten years
- $123,468 in interest and $105,692 on the house in twenty years
- $143,739 total in interest and outright own the property in thirty years
You’ll pay $343,739 total, on the $200,000 you borrowed. Even with the low interest rate of 4%, you’ll spend hundreds of thousands of dollars in interest.
If you hustle and pay off your mortgage in five years you’ll spend $20,862 in interest, a savings of $122,877.
But Wait, Aren’t There Tax Breaks with Mortgage Interest?
One major argument for not paying off your mortgage is to continue to get the tax break on your mortgage interest. Reports show approximately 46% of homeowners with a mortgage get no tax break at all, and those that do get a tax break, don’t get a dollar-for-dollar deduction.
Only a tax credit gives you a dollar-for-dollar deduction. You get pennies on the dollar for tax deductions. You’re eligible for the mortgage interest deduction only if you spend more in interest than the standard deduction of $12,700 for married filers, or $6,350 for single filers. The tax benefit is a fraction of the interest spent above the standard deduction.
The Battle Between Investing or Paying off Mortgage Early
The stock market historically earn significantly more than the increase in real estate values and the interest rates on mortgages. Time is money with investing and sooner you start the more your money can compound and grow.
Let’s see some numbers with disposable income put to work in six different scenarios with a focus on crushing your mortgage versus investing.
Crush your Mortgage
Scenario # 1
Here you delay investing entirely until your mortgage is paid off and pay an extra $2,750 monthly towards your mortgage. At age 35 you have the home paid off and then invest the amount of your mortgage payment ($955) to retirement.
Here you’re missing valuable time to invest young.
Retirement Account at Age 65: $2,085,072
You invest a base amount of $475 monthly while paying an extra $2,750 to your mortgage. At age 35 you have a paid for home and continue to invest $475 plus what you were paying towards your mortgage, $955.
I’m liking this plan.
Retirement Account at Age 65: $3,966,297
Here you have the intensity to pay off your mortgage early, and you keep that intensity once your home is paid off. You invest a base amount $475 monthly while paying an extra $2,750 to mortgage. At age 35, you’re mortgage-free. You continue to invest $475 plus the amount of your mortgage, $955, and the extra $2,750 that was going towards mortgage until age 65.
You’re on fire.
Retirement Account at Age 65: $9,970,430
Keep Mortgage for 30 Years
Scenario # 4
You invest a base amount of $475 monthly from age 30-65 and you’ll have your mortgage paid off at age 60.
You’ve got time on your side by investing young, but your intention to “invest the difference” goes to a new bimmer, boat, and steak dinners instead.
Retirement Account at Age 65: $1,705,023
Scenario # 5
You invest $475 monthly from age 30-60, and then when you have your mortgage paid off at age 60, you invest what was going towards your mortgage to retirement until age 65.
Retirement Account at Age 65: $1,969,647
Here you truly put your disposable income to work by investing a base $475 per month, plus an extra $2,750 from age 30-60 (again, truly investing extra funds), and from age 60-65 when your mortgage is paid off you invest what was going towards your mortgage to retirement.
Can we say, #winner!
Retirement Account at Age 65: $12,860,950
My conclusion: these scenarios all have great outcomes.
If you legitimately invest the exact same funds towards retirement with the same exact intensity of someone who is paying off their mortgage within five years (investing an extra $2,750 per month), then absolutely in a heartbeat you’d be better off with more potential for your money to compound with higher returns historically seen in the stock market.
With the best intentions, in most cases, “investing the difference” versus paying off a mortgage, doesn’t happen. Massive consumerism kicks in with disposable income going towards a boosted lifestyle. Money goes to newer cars, iPhones, jewelry, season tickets to your college football team, etc.
There ya have it, that’s a breakdown of investing versus paying off your mortgage early.
Decisions like these are why it’s called personal finance, what you do with your disposable income, is a personal choice.