Pay Mortgage versus Invest - The Million Dollar Question

Kevin Doe By Kevin Doe, 16th Oct 2017 | Follow this author | RSS Feed
Posted in Wikinut>Business>Investment

Pay Mortgage versus Invest - The Million Dollar Question

Pay Mortgage versus Invest - The Million Dollar Question

If you’re already not managing your mortgage, chances are you’ll be doing so pretty soon. Paying off more than the mortgage versus investing the additional money – that’s a puzzle that faces thousands of home owners every day.

Quite possible, you’re already tempted to believe, without a doubt, that paying off any kind of debt is the right decision. Only once the debt is paid off, can you truly treat your money as disposable, and hence confidently explore investment options. After all, paying a fixed installment for the next 25+ years of your life doesn’t sound like financial freedom. However, the true answer to this question is not really so simplistic. Even when we factor in time value of money, average expected returns on investment, and inflation, the answer is not straightforward.

In this guide, we will explore the possible answers to this question to a deeper level, so that you can apply the knowledge to your situation, and make the right choice. We’ll specifically explore the answer by evaluating the pros and cons of paying off mortgage earlier.

Options of Paying off Mortgage Earlier

Here are some ways you might consider for paying off your mortgage earlier:
• By adding a lump sum amount to the principal repayment in your monthly mortgage payment
• By making bi-monthly payments instead of monthly payments; this could result in cutting off as many as 6 years from an average 30 year mortgage
• Refinancing to a shorter term, which reduces the total value of the interest you pay on the principal, although the monthly outflow increases

It’s clear; for all these 3 options, you are essentially giving away the opportunity of investing some of your money, and choosing to include it in mortgage payments. How advantageous is this? Let’s explore.

The Undeniable Advantages of Paying Your Mortgage Off

Here are the benefits:

1. Save money on interest

It’s obvious; more the principal repayment you can complete sooner, for smaller duration you’ll pay interest on the smaller remaining amount. For a 30 year mortgage, this sum could be colossal.

2. Peace of Mind

Though not translatable into monetary value, the peace of mind of knowing that you own your home can be invaluable. You won’t have to live with the worry of the bank taking over your property in case you suffered from a financial setback or crisis(be sure to check latest financial news to avoid this) that would render you unable to pay back the loan. This, for many people, is the idea of financial freedom, and hence there’s a lot of notional value attached to the sense of complete ownership of one’s home. For anybody living in a financially and economically uncertain and volatile environment, there would be a lot of sanity in making such a choice.

3. Reduced Cost of Living

Inarguably, mortgage is the biggest living expense for many people. By paying off a significant part of the pending loan amount, they can reduce this monthly outflow. This dip in cost of living enables them to save more, work for smaller number of hours, and even explore options such as a career change, which would have been too risky otherwise. For anybody with clear near term savings goals, this is a viable option.

4. Lower or No Private Mortgage Insurance (PMI)

By accelerating principal repayment, your home equity will quickly reach the threshold where PMI will just not be needed anymore. This means that you save money otherwise spent on PMI much before you initially planned. Though this factor doesn’t offer significant independent motivation to home owners for accelerating payments, it does add to the financial benefits of early repayment.

5. Quicker Access to Special Legal Privileges Associated with Home Equity

Many states’ legislations provide special protection to home equity in case of legal proceedings and lawsuits. Retirees can sometimes rely on home equity as a lever for better estate planning to protect assets for dependents, particularly when one of the partners is expected to consume a lot of the equity's worth because of illness. This is very specific case when paying off mortgage could make a lot of sense for someone.

6. Other Scenarios Where Paying Off Mortgage Makes for The Right Decision

- For the elderly, who’re nearing the end of their mortgage, it makes more sense to complete their liabilities than invest.
- For anybody looking at the possibility of having to withdraw from tax deferred accounts after retirement to pay off mortgage, it’s much worthier to pay off mortgage now than invest.
- For people faced with the decision of using their lump sum money to either pay off debt, or invest in highly risky markets, debt payment is often the smarter choice.

The Hidden Variables That Make Early Mortgage Payments An Iffy Financial Decision

Now, let’s explore the other side of the coin, the cons of early mortgage repayment.

Losing High Value ROIs for Low Value Tax Breaks

Many people make lumpsum loan repayments, motivated with the idea of being able to get higher tax savings for the higher repayments. However, tax exempt mortgage repayments are subject to many interwoven and complex rules that differ from state to state. If the yearly tax exemption you will get doesn’t alter much in spite of repayments, there’s hardly any compelling financial reason for you increase mortgage repayment. Instead, invest the money.

Losing Almost Double the Value of Your Money!

A diversified portfolio can fetch you anything close to 8% returns in the long term. Compare it to the cost of your mortgage. For a 6% mortgage, and considering you come in the 35% tax bracket, the effective mortgage rate after accounting for tax deductions becomes 4%. So you're looking at potentially double the return by withholding accelerated mortgage repayments and investing the money instead. A good hybrid strategy is to pay off the high cost, non deductible debt component, and then invest the remaining disposable monthly income.

Your Notional Savings Are Lower Than You Believe

If you clear off close to half your pending mortgage and, let’s say, reduce the remaining period from 20 years to 12 years, the financial worth of your ‘saved’ dollars will be less than what you believe. That’s because:
• True ‘savings’ will only start when you pay off the remaining mortgage
• By then, inflation exposure would eat away at the ‘net present value’ you attach to that money today.

So, for anybody looking at a fairly long period of pending mortgage payment in spite of the lump sum repayment done today, it might be a smarter decision to invest.

Other Factors That Make Investments A Sweeter Financial Option Than Mortgage Repayments
- When mortgage interest rates are low, and even lower than inflation; you’re practically gaining value on every dollar you take up on interest!
- For anybody who (often rightly) can’t really place trust in property as a sustainable source of value.

It’s clear; the options of using lump sum money to repay mortgages can be the right decision, provided you find yourself in the right financial situation. In many contrary cases, it will be a smarter choice to invest the disposable income after paying off the monthly installment of your debt.

moderator Peter B. Giblett moderated this page.
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