Pay More Mortgage or Invest Money?
Yesterday I wrote an article on how paying a little extra on your mortgage has huge long term effects because of how long your mortgage is but some of you might be thinking, wouldn’t that money be better served if you were to invest it into the stock market? I mean if we follow the historic numbers of 11%, or even the more conservative 8% or 9% number, we would still come ahead on a mortgage at 6% interest right?
Yes! You can potentially earn more money by investing your money in the stock market than paying down your mortgage. I totally agree. So why did I tell people that they can save a ton of money by paying down their mortgage when they could make more by investing?
I wrote that because one of the fundamental principles of prudent investing is diversification. The stock market doesn’t return 11% year in and year out, it returns that average over many many years. With your mortgage, that return is guaranteed. So, diversify your investments by putting a little into the mortgage and a little into the stock market and you’ll come out ahead.
If you always try to swing for the fences, you’ll strike out more than average… just ask Alfonso Soriano.
13 responses to “Pay More Mortgage or Invest Money?”
broknowrchlatr responds:
Posted: April 10th, 2007 at 8:44 am
For me, it is a no-brainer to invest in some way. My mortgage is at 4.875% and even a high yield savigns account can do better than that.
But what to do with it is another question. For now I am putting it in a CD earning 5.1%. I don’t want to put it in anything risky because I will need it when we move in 4-5 years.
Patrick responds:
Posted: April 10th, 2007 at 9:21 am
Hi Jim,
I agree with this post. I round my mortgage payment up to the next $50 mark (about $48 a month extra). It makes it easier to remember the exact amount to pay every month, and an extra $50 is not going to make a huge increase in my investment portfolio.
Kepp in mind though, that for most people, the mortgage interest they pay is tax deductible, so that 6% interest rate does not actually equal a 6% return after taxes. It might be closer to 4.5-5% But, it is guaranteed, and the piece of mind of knowing how much money you are saving in the long run and how much more quickly your mortgage will be paid off is well worth the small difference.
Michael responds:
Posted: April 10th, 2007 at 10:48 am
Hi Patrick,
I used to be a big supporter of paying off mortgages early, and still look for waus to pay down early, but financially it makes more sense to invest the money instead of putting it towards your mortgage.
The extra $50 you are putting towards your mortgage each month will knock 16 months off of your mortgage and save you $30,348 in interest (with a 6% rate and a $500k mortgage). That same $50 a month invested at an annual return of 6% would get you over $50,000 in 30 years.
I guess it really comes down to the goal for the investor. If you are looking to pay off your mortgage as soon as possible, or are you looking to make the most out of every penny (even if it means carrying a mortgage out to 30 years).
KMC responds:
Posted: April 10th, 2007 at 12:32 pm
You can’t argue with math and what the previous comments say is absolutely correct. Assuming you have a low mortgage rate, you could do better in a CD. The thing is though, for me, I DON’T CARE. I send almost $200 extra to the bank every month for principal curtailment. I am fully aware it is technically against my financial self-interest. But a key goal of mine is to retire the mortgage, so I don’t care if it’s ultimately costing me some money. My piece of mind is worth the price.
Stephen Snyder responds:
Posted: April 10th, 2007 at 2:56 pm
I agree w/ the diversification plan. I add an extra $150 to my mortgage each month, and invest the rest.
Miller responds:
Posted: April 10th, 2007 at 6:39 pm
It’s already been hit on, but I repeat it. Mortgage interest is deductible, and some stock market gain (dividends, turnover, etc.) is taxable. So add up the numbers for your given situation.
What you might find is that while one is better than the other, it might be marginal. This is kinda like rate chasing with online savings accounts. Oooh, an extra 0.05%??? Yes, its financially better, but as Michael mentioned, there might be other considerations. Simplicity of life might be one of them. Maybe its just *easier* to pay down the mortage instead of making ~$100 extra each year. The old saying, “time is money” too.
Also, someone people just don’t like being in debt. They might prefer to pay down the mortgage just for peace of mind.
Anyway, my main point is run the numbers as accurately as possible and if the difference is small, go with what makes you happier. That may or may not be the strict “financial” answer.
Lazy Man and Money responds:
Posted: April 10th, 2007 at 6:49 pm
“The stock market doesn’t return 11% year in and year out, it returns that average over many many years.”
When you say “many many years”, would you say that 30 years would be enough - the typical mortgage length?
If so, then what about say 25? At that point you could pull the money out around then and pay off your mortage with it. I know, the stock market could crash at that year 25. In that case, maybe you’d want to take some of that money out of the market every 5 years (if the market has done well) and take the guarenteed pay off.
wanzman responds:
Posted: April 10th, 2007 at 8:03 pm
One thing to consider is the aspect of liquidity. When you pay down the mortgage, you do get that guaranteed return. But one thing is, what if you have an emergency, you need a new car, or something like that? Then you must use a home equity loan to get at the funds you have been putting into reducing your mortgage. On the other hand, if you just make you normal payments and invest the rest into something else, in times of need (or want) you will be able to pull the money out, usually just by paying trading costs.
My main point here is that paying down the mortgage or investing in something both create an asset for you. However, in my opinion I would want an asset that I would easily be able to put to work. If the extra money was tied up in the house, it might be a longer, more costly process to get the money if/when I needed it.
Peter responds:
Posted: April 11th, 2007 at 6:01 pm
One great thing about long term debt is that inflation has a longer time to work on it. Yes, you are paying more in interest, but the payments are increasingly less in real terms. At 3% inflation, your payments in the last year of a 30 year mortgage are just 42% of the nominal value.
alex responds:
Posted: April 11th, 2007 at 7:04 pm
I disagree with the diversication argument. Most people (myself included) already have far too much of our assets in real estate.
For instance, I have roughly 50K in home equity in the house I own, combined with 50K in other investments, thus 50% of my assets are invested in one item of real estate, talk about a lack of diversity! I need a lesser percentage to be in my house for diversity purposes, not a greater percentage.
dong responds:
Posted: April 11th, 2007 at 9:28 pm
I’m with Alex on this, most people already have too much tied to real estate as a portion of their porfolio. I think real estate can be great investment, but I bet alot of people who are putting extra into the their mortgage are likely people who are not putting enough into other types of “riskier” investments.
Ask the Readers: Is It Better to Invest or to Prepay a Mortgage? ∞ Get Rich Slowly responds:
Posted: June 1st, 2007 at 8:27 am
[...] fellow pfbloggers, Blueprint for Financial Prosperity and Million Dollar Journey, recommend that a person do a little of both: pay down the mortgage some [...]
Kris responds:
Posted: November 14th, 2007 at 10:07 am
Diversification is the key. Evaluate your own situation and diversify your assets. I am 95% in the stock market - so it was an easy decision to pay off my mortgage early. Its been great to be completely debt free, not even a mortgage payment, for the last 2 years!