It is conventional wisdom that paying off your debts before investing your money is the best course of action. After all, it doesn’t make financial sense to carry a credit card balance at upwards of 15%, while earning 8% or less on your investments. While it is always a good idea to pay off credit card debt and car loans as quickly as possible, it may not be as clear with a mortgage.
A mortgage is commonly considered a “good” debt, due to low interest rates, tax benefits, and owning a valuable asset. When looking at the true cost of a mortgage over the life of the loan, however, it may be startling to find out how much your investment truly costs in the end.
While paying off your home loan early could save you tens if not hundreds of thousands of dollars, you may be asking yourself if there is a better way to put your capital to work. The answer to the question “should I pay off my mortgage instead of investing?” will depend on several factors, and will require careful consideration.
Figure Out What Is Important To You
It is probably safe to say that if you are asking yourself this question then you are on pretty solid financial ground. Assuming that all other debt has been paid off, you can devote your attention to this important question.
One way to get an answer is to simply ask your self what is more important to you and your family: owning your home free and clear, and carrying no debt into retirement, or building a comfortable nest egg and inheritance for the future?
Remember that carrying a mortgage has no bearing on your home’s value. Housing prices will fluctuate according to market conditions, and your home will rise and fall in value regardless of what your mortgage is.
Do The Math
Sometimes it is more advantageous to invest your money rather than pay down mortgage debt if your gains can outweigh the interest you pay on your mortgage. By investing excess capital every month in lieu of paying on your mortgage’s principle, you are performing an arbitrage – borrowing money cheaply (your mortgage) and investing it at a higher rate (stocks) with the difference being your profit.
You can increase the odds of your investing success by using a low-cost stockbroker, investing in high-quality, dividend paying securities, reinvesting your dividends, and maintaining your positions for at least five years.
It is important to keep in mind that the arbitrage gap is not definite, as you have no way of knowing what return (if any) you will get on your investment. There is no investment out there that can guarantee any specific investment gains, so this avenue can carry a lot of risk.
You may not have to decide whether to pay off your mortgage or invest, you can do both. By paying your mortgage off, you are effectively reducing your need for cash flow when you enter into retirement. When you are free of this burden you are better positioned to handle any financial surprises the future may hold.
Review your budget carefully and decide how much you can allot for investing, and how much you can devote to paying off your home loan. By devoting even relatively small amounts to both goals, you can watch your investments grow, and your mortgage shrink over time.
By allocating funds every month to both pay down your mortgage debt as well as invest for the future, you are building and preserving your wealth at the same time, better positioning your self for retirement, and protecting your legacy for future generations.