By Bryan Lee, CFP®, MBA
Making financial decisions can be a daunting task, especially when it comes to managing one of your biggest investments—your home. Many homeowners often find themselves at a crossroads, wondering whether they should focus on paying down their mortgage faster or investing their funds elsewhere.
Let’s explore the pros and cons of both strategies and shed light on the age-old dilemma: Should you pay down your mortgage or invest the money?
What Makes the Most Financial Sense?
When deciding between these two options, you first want to know which option can provide the greatest payoff. In this case, it’s your mortgage rate versus your expected investment return. You can calculate some rough estimates to evaluate which decision would make more financial sense.
Let’s consider an example. Say your mortgage interest rate is 5%. If you estimate that, based on your risk tolerance and time horizon, you can expect a long-term investment return of 4%, it would make more sense to pay down your mortgage. Otherwise, you’re potentially throwing away 1%. However, if you are a more aggressive investor and believe you could earn 8% on your investment, it would make more sense to invest.
This may sound simple on paper, but there are a lot of factors at play. And as we all know, even the best of predictions aren’t set in stone. It’s important to run a thorough analysis and factor in taxes on investments, mortgage interest deductions, risk, and private mortgage insurance, among other elements of your financial life. An experienced wealth advisor can run all of the calculations and do a complete analysis of your unique situation.
The Pros and Cons of Each Option
There are some pros and cons to each that go beyond the raw math. Liquidity is one big advantage of investing. You’ll have easier access to funds in case of an emergency. However, if you put the money towards your mortgage, your ability to access that capital is more limited. The only way to get the money back out is to sell your house, take cash-out when refinancing, or take out a home equity loan or line of credit.
However, an advantage of paying down your mortgage is that your house will be paid off sooner. You will have a greater likelihood of being able to enter retirement without a mortgage, or at least have your mortgage paid off sooner into retirement. That way you can free up more of your money before your hobby, travel, or other medical expenses start to build. If you invest, your mortgage will be another bill you have to pay while in retirement. However, if you hadn’t invested those funds over time instead of using them to pay down your mortgage, your investment accounts wouldn’t have grown as quickly. Therefore, your mortgage interest rate relative to your expected rate of return on your investments is still the primary factor.
Another benefit of paying off your mortgage completely is decreasing your risk. Once you own your home free and clear, you never have to worry about a foreclosure or having your credit damaged by missed mortgage payments. Once the mortgage is paid off, you have more funds that can be applied towards investing to help catch up on years missed when paying down the mortgage more quickly. However, keep in mind that even without a mortgage, you still have to pay your home insurance and property taxes, so there will also be some level of housing costs.
Choosing a Combination of the Two
For some people, it may make more sense to choose a combination of these two options. For example, if you have less than 20% equity in your property, you may be required to pay private mortgage insurance, meaning you owe additional premiums on top of your mortgage principal and interest payments.
In this case, even if your mortgage rate is 5% and you can earn 6% on an investment, you may still earn a higher return on your money by paying down your mortgage. Once you pay it down to at least 80%, then you free yourself of needing private mortgage insurance and begin investing more should you determine that that’s a more appropriate option for you.
In the past few years, we have helped many clients refinance their mortgages to some of the lowest rates we have ever seen. If that is the case for you, then it is likely that the best financial answer will be to continue paying the minimum mortgage payment each month and contribute more to your investment accounts (especially if they can grow tax-free). However, we know there is peace of mind that comes with paying off the mortgage, and we will help talk through all of the pros and cons so you can make an informed decision.
How We Can Help
The decision to pay down your mortgage or invest the money ultimately depends on your individual financial goals, risk tolerance, and current financial situation. Both options offer potential benefits, but they come with their own set of considerations and uncertainties.
Do you need help determining which option is right for you? The Strategic Financial Planning team would love to partner with you on this major financial decision—and others—to help you move closer to your ideal financial future. Call us at (972) 403-1234 or contact us online to set up a complimentary get-acquainted meeting so we can see how we can help.
Bryan Lee is the founder and president of Strategic Financial Planning, Inc., an independent, fee-only financial advisory firm. With more than 27 years of industry experience, Bryan uses a unique client-first financial life planning approach and process to help his clients get the most out of life. Bryan earned his Bachelor of Business Administration in finance and his MBA in international finance from the University of North Texas. He is also a CERTIFIED FINANCIAL PLANNER™ professional.Bryan is actively involved in his community and industry and has served on the boards of several associations and charities, including the Dallas/Fort Worth chapter of the Financial Planning Association, the National Association of Personal Financial Advisors, Family Services of Plano, the CITY House, and the Journal of Financial Planning. Bryan has been featured in local and national media, including The Wall Street Journal, Investors Business Daily, CNNfn, USA Today, SmartMoney, Kiplinger’s Personal Finance, Financial Planning Magazine, The Dallas Morning News, and Dow Jones Newswires. And, he has been recognized as a Five Star Wealth Manager and one of Dallas’s Best Financial Planners in D Magazine every year since its inception and recently as a Top Wealth Manager. To learn more about Bryan, connect with him on LinkedIn.