Is paying off your mortgage the smartest investment you can make in 2019? Or what about investing your money instead, whether it’s in stocks or real estate?
Paying off a mortgage vs. investing that money instead is a very personal decision that depends on factors like the rate on your mortgage, whether it’s fixed or variable rate, your retirement savings and emergency savings, your age, and if you itemize and write off mortgage interest on your taxes.
Here’s how to decide, and what I personally plan to do.
Paying Off Mortgage Vs. Investing: My Situation
Here’s my actual situation. I’m 31 and have owned my home for 2.5 years.
Through a lot of hard work and frugality, I’ve been able to save up just over $100,000, which I put into a CIT Savings Builder account.
As of writing, the savings earns 2%+ interest, with virtually zero risk since it is backed by the FDIC. So I can make about $2,000 per year in interest. I will have to pay some taxes on the earnings, however, since it’s not held in a retirement account.
The balance is around $320,000 at 4.5% APR (fixed-rate), so paying down my mortgage earns me an effective rate of return of 4.5%, or 2.5 percentage points higher than the savings account. I don’t have enough to pay off the entire mortgage, but could make a significant dent.
I also pay $85 in PMI (private mortgage insurance) per month, since I originally put 10% down to buy the home a few years ago. I would need to pay off around $20,000 to eliminate the PMI, since PMI is eliminated when you reach 20% equity in the home. You have to request it in writing to your lender, be current on payments and get your home appraised.
My options for investing
They include the stock market, which has returned about 10% on average per year since its inception. However, the stock market is still trading near all-time highs and the Federal Reserve keeps raising interest rates, which isn’t good for stocks.
Bonds are safer than stocks and riskier than savings or money market accounts, but don’t return more than 4.5%, so that’s out of the question, as I’d rather pay down the mortgage.
My other option is to invest in cash flowing real estate, like the deal I did on Roofstock. This also carries risk (what if the tenants don’t pay or trash the place?), but higher potential yield, as many rental properties yield 5% – 10% returns, not counting the tax benefits or debt paydown.
Like stocks, real estate could drop in value, too. Also, today’s mortgage rates for investment properties are over 5%, even if you put 25% or more down.
My current plan
I have enough of my assets in stocks and not a lot of real estate. I plan to pay down my mortgage a little bit while investing in real estate via the BRRRR method. I think this will provide me with the best returns in 2019.
Paying Off Mortgage: What Would You Save?
Here’s what you can expect to save by paying off a mortgage early.
Let’s say you bought a house for $250,000 and put down 20% or $50,000, with an APR of 5%. Five years passes, and the mortgage balance is now paid down to $183,658.
You hit the lottery and now have enough cash to pay off the mortgage in full. Congrats! By paying off the loan early – the entire $183,658 balance – you’d save over $137,000 in interest and completely eliminate your $1,074 monthly payment, according to Zillow’s mortgage calculator.
That’s an effective annual return of 5% and a guaranteed savings of $137,000, which isn’t bad at all!
Investing the Money: What Would You Earn?
The other scenario is investing the money instead over a period of 25 years.
Let’s say you take that $183,000 you won from the lottery and put it in a standard S&P 500 index fund, and re-invest the dividends. Over the course of 25 years, you manage to earn a return of 5%. This is an average return; some years you may earn negative returns, and some years may be positive.
By the end of the 25th year, you’d have saved $619,703. The returns are higher because of the power of compound interest: the interest you earn on the investment continues to grow and grow and earn even more interest.
*Note: These returns are by no means guaranteed and also don’t factor in taxes. You can reduce the tax burden by keeping the stocks in an IRA, but you can’t touch the money until you retire (or you’ll face penalties and taxes).
If you hold the investments in a taxable brokerage account, you’d have to pay taxes on dividends each year or if you sell the stock at a gain.
Using an after-tax rate of return calculator at Merrill Edge and plugging in a 25% tax rate, stocks that have a 5% pre-tax rate of return actually return 4.25% when taxes are factored in. So, your investment is actually worth $519,890 after 25 years. Still a huge win!
Over the long-term, it seems like a combination of investing in real estate and stocks is likely my best bet.
Paying off your mortgage vs investing: factors to consider
- Do you have enough cash in an emergency savings account? Most financial advisors recommend having at least 3 to 6 months of expenses saved up. You don’t want to deplete your entire savings to invest or pay down the mortgage.
- Do you have any consumer debt, such as credit cards or store department cards? These typically carry rates exceeding 15% and should be the first debts you pay off!
- How close are you to retirement? If you don’t have enough saved, it may be worth funding your retirement accounts instead of paying down the mortgage.
- Where are you in the mortgage payoff process? I think this is one thing that people tend to overlook or miss when deciding on whether or not to pay off a mortgage early. Mortgages are amortizing loans, which means you pay more in interest and less in principal at the beginning of your loan.
- For this reason, it may make more sense to pay extra on the mortgage if you just recently took it out. But if you’re really close to being mortgage free, you may just want to pay it off to have the peace of mind of not having a mortgage anymore. Just keep in mind that you’ll still have to pay property taxes and insurance on the house.
- Do you like taking risks? If you are someone who doesn’t like to risk your money investing, paying off your mortgage is a better choice as the returns are guaranteed.