Paydown or Invest?

Is It Better to Pay Down Your Mortgage Faster or Invest?
excerpted from apartmenttherapy.com

by Liz Steelman

It is a fact that you could save significantly on interest by paying a little bit more towards your principal over the scope of your home loan. However, it is also true that instead of paying more toward your principal, you may benefit more by investing that same money. For example, if the interest rate on your mortgage is 5%, and the current 30-year market growth rate for a portfolio of investments is around 8%, then you should invest that money instead of paying down your mortgage faster.

Let’s look at how this using some very simple numbers: If you have a $300,000 30-year, fixed-rate mortgage at 5% interest and you commit to paying an extra $100 every month, you’ll save nearly $40,000 in interest over the term of the home loan. However, if you opt to put that $100 monthly payment into an investment that compounds annually with an 8% rate of return of 30 years, you’re likely to end up with $140,855 when your mortgage ends. You will, however, have to pay the extra $39,937.25 on your mortgage by forgoing the extra principal payment. So your actual return will only be around $100,000. However, that still is considerably more than $40,000. This, however, is a simplistic look at the concept, but it gives you an idea on what the rate of return of investment could be.

Financial experts note that it is always a smart idea to look at the spread (the difference between the two interest rates) between what you could get through investing versus your mortgage rate (which drives what you can get early-paying your mortgage). However, these days an 8% return on investment is a little more aggressive than reality. Additionally, investment rate of return usually doesn’t include tax considerations—which can affect your rate of return (since mortgage interest is tax-deductible. Additionally, the investment timelines for portfolios with 6-8% return are usually long-term return rates. So consider how long you have left on your mortgage and compare it with the term required by your investment.

On top of that, investment rates are not often guaranteed. And, if you do earn slightly more with an investment, the freedom and peace of mind that comes with paying off your mortgage early may be priceless.

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