Introduction
Owning a home is often considered the American Dream. But once you’ve signed that mortgage and have started making payments, the new dream is likely to be the day when you can burn that mortgage paperwork and claim your home as entirely your own. On the other hand, the world of investing offers its own allure, promising growth over time and the dream of one day having enough to retire comfortably. The question is: should you focus on paying off your mortgage early or take that extra money and invest it for the future? This debate has been raging for years, but in today’s financial climate, it’s more relevant than ever. I recently conducted an in-depth analysis of this topic and the findings were surprising.
The Initial Math: It’s More Complicated Than You Think
A Tale of Two Scenarios
In a recently published video, I dug into the financial mathematics of paying off a mortgage early versus investing. To set the stage, let’s consider a hypothetical 30-year mortgage of $300,000 at an interest rate of 7.18%. Now, let’s consider two scenarios:
- Paying an extra $200 a month on your mortgage: By doing this, you could save $121,618.96 in interest and pay off the mortgage seven years early.
- Investing $200 a month in the stock market: Assuming an average annual return of 7%, you’d gain a total of $161,891 over 30 years.
At a first glance, investing seems to be the better option, offering $40,272.04 more than paying off the mortgage early. However, there are nuances that can dramatically alter this seemingly straightforward calculation.
What We’re Overlooking: The Power of Additional Years
If you decided to pay off your mortgage seven years earlier by adding $200 per month to your mortgage payment, you would have seven additional years without a mortgage payment. During those years, the amount you were dedicating to your mortgage could now be invested. If you decide to invest the sum of $2,232 (your original mortgage payment plus the extra $200) every month for the next seven years at the same 7% return, your investment would grow to $239,135. Astonishingly, that’s more than the portfolio balance you’d achieve by investing $200 monthly for 30 years.
The Factors That Really Matter: Risk, Freedom, and the Unpredictable Market
The Surety of Mortgage Payments vs. Market Volatility
The argument doesn’t end with just mathematics. When you’re paying off a mortgage early, the 7.18% interest rate is a guaranteed ‘return’ in the form of interest you’re not paying. Conversely, the stock market is volatile, and while the average annual return for the S&P 500 has been around 10%, past performance is no guarantee for the future.
The Freedom Factor: A Home Free and Clear
Paying off your mortgage early gives you a peace of mind and freedom that keeping a mortgage for 30 years doesn’t offer. Imagine a scenario where you and the person who opted for investment both face layoffs. You would have the security of owning your home outright, eliminating the risk of foreclosure. On the other hand, the individual still making mortgage payments might find themselves in a precarious situation.
Crisis and Economic Downturns: A Double-Edged Sword
Even if the person with the investment portfolio decides to liquidate their investments to pay off the mortgage in a crisis, they run the risk of selling at a loss. Stock markets are known to dip during economic crises, which could mean your investments might not be sufficient to pay off the remaining mortgage.
Conclusion: One Size Doesn’t Fit All
When it comes to the question of paying off your mortgage early versus investing, the answer isn’t as straightforward as it may seem. While investing may offer the potential for greater financial gain, it also comes with higher risks and less certainty. Paying off your mortgage early provides you with the guaranteed return of saving on interest payments and the emotional and financial security of owning your home outright.
Ultimately, the best decision will depend on your personal circumstances, risk tolerance, and financial goals. It’s a complex equation with variables that only you can fill in.
Feel free to consult with financial advisors and run multiple scenarios to figure out which strategy aligns best with your long-term objectives and lifestyle. After all, whether it’s the freedom of a mortgage-free life or the potential gains from an investment portfolio, both paths offer different kinds of financial security and peace of mind.