Should I Use Surplus Income to Pay off My Mortgage or Invest?

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Should you invest your extra cash or pay off your mortgage before it is due? As with many crucial financial planning decisions, the answer lies in a grey area, not black or white. One of the most typical questions families deal with is whether to accelerate mortgage payments or to try and borrow as much as they can, make minimum debt payments and save up for retirement.

Investing the Extra Income

In a time without emotional or behavioral biases where we all reasonably evaluate the economics and make selections based on probability-weighted outcomes, the math points to investing over debt elimination. Yet the loan decision is rarely ever this simple. It depends on your precise situation – your tax rate, portfolio allocation, credit history, tendency to save and risk tolerance. From a purely quantitative standpoint, the financial benefit to maintaining a mortgage and investing the difference is noteworthy for most homeowners over the past decades.

To help comprehend the economics of the mortgage decision, we will test two scenarios: First, a family uses $200,000 of savings for a home, and invests each month with an amount that would otherwise be the mortgage payment (less the tax deduction). Second, a household invests $200,000 in stocks and bonds while borrowing the exact same amount on a 30-year mortgage.

Over the passage of 42 years, the family that borrows sees an encouraging outcome in 97 percent of the time, which is important for major matters like your retirement. The only period when paying cash would be wiser was between the months of May and Dec of 1981, when the mortgage rates ranged between 16.4 percent and 18.5 percent. If we calculated for refinancing, the mortgage-and-invest approach would be favourable.

Paying Off the Mortgage

If paying off the mortgage is more attractive to you, then here are the several strategies for early mortgage payoff starting with the most modest and moving toward the most complex:

REFINANCz TO A LOWER INTEREST RATE:

Another tactic is to refinance to a lesser interest rate on your mortgage while keeping the term (pay off date) the same. The key is not to take any money out or spread the term when you refinance. The new loan should offer a lower payment as a result of the reduced interest cost. When you continue with the same payment as before, all the extra will go to principal payoff.

REFINANCE TO A SHORTER-TERM:

Rather than pay over a 30-year amortization, try dropping the term to 15 years. The monthly payments will be greater, but the interest rate is usually lower, therefore offsetting some of the monthly outflows. Another variation on this theme is to maintain your 30-year mortgage, but keep making your payments as if it were a 15-year amortization.

ADD PRINCIPAL TO YOUR CURRENT MONTHLY PAYMENT:

Let’s assume your mortgage doesn’t have a prepayment penalty (check first). The easiest early payoff strategy is just to keep adding principal to your regular payment. You could also try a one-time lump sum where you utilize the proceeds from selling a boat, motorhome, or unused jewelry.

BIWEEKLY PAYMENT SCHEDULE:

Rather than making one mortgage payment per month, try making half the payment every couple of weeks. Since there are, of course, 52 weeks in 12 months, that causes 26 half-payments or 13 full payments instead of the usual 12, which is one extra payment per year. Depending on your specific situation, this can cut up to six years off the lifespan of your 30-year loan.