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If you’ve come into some extra cash recently, you’re probably trying to figure out the best way to use it. Your mortgage is probably your biggest debt if you’re a homeowner, so paying it down seems like a no-brainer. But you can also make a case for investing the money toward your retirement instead.
Both options are smart financial moves, but which one should come first? Unfortunately, there’s no one right answer. Everyone’s financial decision is different, so what might be right for someone else may not be right for you. Here are some factors to consider before you decide what to do with your extra money.
Paying off your mortgage early: What to consider
For most people, a house represents their biggest asset as well as their largest debt. Paying your mortgage off early is a great way to get out from under mortgage debt and free up cash for other financial goals.
If you’re early into paying off your mortgage, putting down any extra funds now makes sense. You may not realize it, but most of your mortgage payments go toward interest costs early on, which doesn’t reduce your loan principal. Paying extra earlier in your mortgage can help you knock down your loan principal quicker.
If you’re thinking about refinancing your mortgage to save on interest, you can compare mortgage refinance rates using Credible.
Benefits of paying off your mortgage early
Save money — Perhaps the biggest benefit of paying off your mortgage early is the interest savings you’ll see. Depending on your interest rate and loan term, you could potentially save thousands of dollars, or much more.
Become debt-free — By paying off your mortgage, you cross a huge debt off your list, freeing up funds you can put toward other goals. Carrying debt isn’t only a financial burden — it can be an emotional and mental burden, too. Paying it off can relieve some of the stress that’s tied to debt.
Build equity — Paying off your mortgage helps you build equity in your home quicker. You can leverage your equity to increase your home value or pay off other debts through a home equity line of credit (HELOC) or home equity loan.
Drawbacks of paying off your mortgage early
Less money for other goals — When you’re focused on paying down your home loan, there’s little to no extra money to put toward other goals, like starting a family, paying for college, buying a new car, or building your retirement fund.
No tax deductions — If you pay off your home early, you’ll lose out on tax deductions for mortgage interest. Also, if you’re paying off your mortgage instead of investing, that means you’re probably not maxing out a tax-advantaged retirement account.
Non-liquid asset — While your home has considerable value, it’s not a liquid asset. That means you could run into issues if you face a financial emergency and need to free up cash.
Investing: What to consider
It’s hard to ignore the draw of investing. The thought of earning high returns on your money makes investing a much more attractive option than paying down your mortgage. While there’s no guarantee that your investments will pan out, investing earlier helps you take advantage of one of the best financial tools for growing wealth — compound interest.
Simply put, compound interest Is earning interest on your interest. The interest on your investments is calculated on your deposits as well as interest that’s accumulated over time. The longer your money is invested, the more the snowball effect of compound interest grows your money.
Benefits of investing
Higher rate of return — Investing your money instead of paying off your house allows you to take advantage of higher returns. The U.S. stock market has averaged 10-year returns of 9.2% over the past 140 years, according to research by investment firm Goldman Sachs.
Liquid assets — Having your money tied up in the market instead of your home keeps your assets liquid. You can quickly sell stocks, bonds, or other investments to free up money if necessary.
Retirement matching — Many employers offer to match retirement contributions. Investing more now allows you to max out your 401(k) contributions and take advantage of free money.
Drawbacks of investing
Greater risk — Despite historically good returns, investing is still a significant risk. Depending on how you choose to invest your money, you could actually lose money over time.
More debt — Your mortgage is likely a huge debt burden. Investing instead of paying extra on your mortgage leaves you with debt longer.
No guarantees — There’s no guarantee that you’ll succeed in investing or saving enough for retirement. Paying off your mortgage early leaves you with a guaranteed asset moving forward.
Pay off your mortgage or invest: How to decide
Since paying down your mortgage and investing both offer significant benefits and drawbacks, there’s no easy answer to which one is right for you. Here are some questions to consider that could help you decide.
How long do you plan to stay in your home? If you’re not planning on living in your current home for very long, it might not make sense to dump all your extra money into paying down your mortgage.
Do you have a high interest rate on your mortgage? If your mortgage has a high interest rate, you may want to focus on paying it down early or refinance to a lower interest rate.
What are your financial goals? If you have other financial and life goals to save for, determine which choice helps you meet those goals quicker.
What is your retirement timeline? Depending on how long you have until you retire, you may want to consider investing extra money so that you have enough retirement savings built up.
What is your risk tolerance? Riding the market waves isn’t for everyone. If you have a hard time leaving your investments alone, paying off your mortgage is likely a better guarantee than investing.
If you’re thinking about refinancing, Credible lets you compare mortgage refinance rates from various lenders in minutes.
Do the math
Here’s a real-life scenario so you can look at the math behind both decisions. Let’s say you have a 30-year mortgage with a balance of $250,000, an APR of 3.25%, and a monthly mortgage payment of $950.
In this scenario, if you put an extra $1,000 toward your mortgage each month, you’d save $118,455 in interest over the life of your mortgage. Instead of paying off your mortgage in 30 years, you’d pay it off in just over 13 years.
On the flip side, if you took that extra $1,000 and put it into a retirement fund (assuming a 10% annual return on your investment), in the same 13-year time frame, you’d build a $321,569 investment balance.
Keep in mind that this calculation doesn’t include other factors like existing investment balances, taxes, mortgage interest tax deductions, or the rate of inflation. As you can see, both scenarios provide significant value depending on your financial goals.
Other uses for your extra money
Paying down your mortgage and investing aren’t the only ways to spend extra funds. Depending on your financial situation, these other options could have a greater impact.
Pay off higher-interest debt — Some debt is more costly to carry long-term than others. If you have existing credit card debt or personal loans with high interest rates, use your extra funds to get out from under this debt as quickly as possible.
Build an emergency fund — Having a properly funded emergency fund provides peace of mind so that you can confidently pursue other financial goals.
Another option to consider: Refinance and invest
If you’re still having trouble deciding the best course of action, why not do both? In this situation, you can have your cake and eat it too: Split your extra earnings and apply it toward paying down your mortgage and investing for retirement.
With mortgage rates at historic lows, refinancing is another way to lower your mortgage. Depending on your credit, you could score a low interest rate, shorten your loan term, or lower your monthly payments. Refinancing can help you free up more money to invest as you please and earn higher returns. Most mortgage lenders let you check rates for free without negatively affecting your credit score.
Depending on your situation, it might be a good idea to consult a financial advisor who can analyze your finances and help you determine the best course of action. When looking for a financial advisor, make sure they’re a fiduciary financial advisor — fiduciary financial advisors are required to put their clients’ best interests first at all times. The National Association of Personal Financial Advisors and Financial Planning Association can help you locate a local planner to meet your needs.
In the end, it’s hard to make a bad choice, whether you decide to pay off your mortgage early or invest the money instead. Either way, you’re investing in your financial future and making a positive impact on your net worth.
If you’ve decided to refinance your mortgage, Credible lets you compare mortgage refinance rates from multiple lenders.
About the author: Kevin Payne is a finance and family travel expert. He writes about credit cards, travel, student loans, saving money, homeownership, careers, and entrepreneurship. His work has appeared in Forbes Advisor, The Ascent, FinanceBuzz, Slickdeals, Student Loan Planner, and more. He is working toward accreditation as an Accredited Financial Counselor (AFC).
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