Should you pay off your mortgage or invest your extra cash?
Many young individuals feel an incredible pressure when looking at their mortgage statement. I remember the very first time I went online after buying my first house: the only thing I saw is that I owed $184,000 to the bank. This was almost 200K! At first, your heart stops beating, you are gasping for air, your brain slows down; time freezes. Is there any worse feeling? Probably the one you have when the foreclosure letter for this 184K mortgage arrives via a bailiff ;-).
This is why many people believe they are better off debt free and focus on paying off their mortgage as fast as they can. But are they really doing the best thing by paying off their mortgage loans instead of investing their extra savings?
I think you are better off investing your money than increasing your mortgage payments.
Yup! I am not part of those anti-debt group. I think debt is really good for you. However, you better know how to manage your personal finances and get control over your debt to create wealth with your money.
Let’s start with the facts: Mortgage or Investment?
If you take this debate on a pure battle of numbers, you will end-up with the same result after 30 years or so. In fact, if you put all your savings towards your mortgage, you will end-up with a net worth equal to the scenario where you pay your mortgage according to the regular schedule and invest the difference. However, in order to get the same net worth, you must keep using the same amount used for your mortgage payment and start investing it once your mortgage is paid off.
Do you have this discipline of paying off your mortgage faster and then, investing the very same amount, in its entirety?
Imagine that you have been struggling for 15 years to put $1,500 per month on your mortgage in order to pay it off in 15 years instead of 25 or 30 years. What is your reward after 15 hard years? You need to keep struggling to invest the very same amount ($1,500) in the markets in order to get even with scenario #2! Do you have this discipline? I’m not quite sure….
The power of compound interest
There is another reason why I prefer investing money than paying off my debts and it’s called the marvellous power of compound interest! While interest on your debt is paid as it is charged, interest on your capital is being added year after year. Therefore, if you have 100K of debt at 5%, you will always pay $5,000 per year in interest (if you don’t reimburse the capital).
However, if you invest 100K at 5%, the first year you will make $5,000. Then, the second year, you will make 5% on $105,000$ and not $100,000. Therefore, the interest earned during the second year is $5250. $250 more in your pocket during the second year already. And the number keeps growing year after year. If there is only one financial principal you have to understand in life, it is the compounding of interest.
I don’t even pay my mortgage back! I invest everything!
Yup, I could be categorized as a financial extremist ;-). I truly believe that compounding interest is way better than paying off debt with my hard earned money. Therefore, I just pay interest only on my mortgage and I invest the difference in the stock market (or my online company). While the bank doesn’t like it because I always keep the same level of debt, let me tell you that my level of assets has increased a great deal over the past 5 years.
I don’t recommend that everyone be that extreme. After all, I work in the finance industry and I know what I want to accomplish and follow what I am doing very closely. I would not take such “risk” if I wasn’t working in this field. However, I truly believe that if you have an extra $200 per month, you should invest it instead of putting it down as a capital payment on your mortgage.
If you slow down your debt payoff process to buy a car, go on vacation or eat out, you are wasting serious money. However, if you prefer to buy assets (invest your money) instead of paying off your long-term debt, you have a seriously good chance of growing your net worth much faster!
So here what other Money Mavens think about whether you should pay off your mortgage or invest your money:
Free Calculator to Pay Off your Mortgage or Invest @ Wealth Pilgrim
Mortgage or Save @ Joe Taxpayer
Pay Off Mortgage Sooner, Invest, Or Save? The Math Analysis @ Money Help For Christians
Should You Grow Your Nest Egg or Pay Off Your Mortgage? @ Enemy of Debt