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 37% of Americans outright own their homes with no mortgage according to MSN. Is that a smart move?
Brendan, a student from Best Money Class Ever, (who paid off his car and credit card, over $8,000 within four months!) is now a homeowner. 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.
He wrote:
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 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 which financial indicators show you’re ready for a home.
Let’s geek out on finance and dive into the battle between aggressively paying off your mortgage debt versus investing.
Here’s the assumptions we’ll start off with the debate to payoff mortgage vs. invest:
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.
First 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 the breakdown on how much you’ll spend in interest over the life of the loan:
- 10 years, you’ll pay $72,147 in interest and $42,433 on the house
- 20 years, you’ll pay $123,468 in interest and $105,692 on the house
- 30 years, you’ll pay $143,739 total in interest and outright own the property
You’ll pay $343,739 total, on the original $200,000 you borrowed, so even that seemingly low interest rate of 4% results in hundreds of thousands of dollars spent on 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 that approximately 46% of homeowners with a mortgage get no tax break at all. 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 Debate to Payoff Mortgage vs. Invest
The stock market does 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.
Scenario # 1: Crush your Mortgage
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
Scenario #2: Invest While Crushing your Mortgage
You invest a base amount of $475 monthly while paying an extra $2,750 to 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
Scenario #3: Keep the Intensity
Here you have an intensity to pay off your mortgage, 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
Scenario # 4: Keep Mortgage for 30 Years
You invest a base amount of $475 monthly from age 30-65 and you’ll have 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: Keep Mortgage for 30 Years and Then Increase Investing
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
Scenario #6: All Out in Mortgage Payoff and Investing
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 in the Invest Vs. Payoff Mortgage Debate
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, does not happen. Massive consumerism kicks in with disposable income going towards a boosted lifestyle with newer cars, iPhones, jewelry, season tickets to your college football team, etc.
There ya have it, that’s a breakdown of the debate to invest vs. payoff your mortgage early. Decisions like these are why it’s called personal finance, what you do with your disposable income, is a personal choice.
