Most of us know that we need to maximize our retirement savings so it lasts as long as we are alive. We also know that one of the ways to do this is to minimize debt so that we aren’t using our precious nest egg to pay off loans. But while it’s always a good idea to pay down high-interest debt such as credit cards or student loans, what about your mortgage? Mortgage debt is often seen as “good debt,” but does that mean you should keep it around?
If you find yourself in a healthy financial position in life with some extra cash to allocate, you may be wondering if you should use it to pay down your mortgage. But would it be wiser to invest it instead? Like most financial choices, the answer is going to differ depending on your unique situation. Let’s look at the pros and cons of each strategy.
The most important factor when evaluating your options is that of growth. You don’t want to leave the additional funds sitting in a savings or checking account where you’re earning less than a percent of interest. You want your money to work for you, so the question to ask is, “What option will give you the biggest payoff?” In this case, you’ll find the answer by pitting your mortgage interest rate against your expected investment return. You can calculate some rough numbers to assess which decision would make more financial sense.
Let’s take a look at an example to give you some context. Say your mortgage interest rate is 5%. If you estimate that you can pursue an investment return of 4%, based on your risk tolerance and time horizon, it would make more sense to pay down your mortgage. Otherwise, you’re potentially throwing away 1%. However, if you are an aggressive investor and believe you could earn 8% on your investment, it might be more beneficial to invest.
This may sound simple on paper, but there are plenty of factors that could affect the outcome. And as we all know, even the best estimates aren’t guaranteed. It’s important to run a thorough analysis and consider taxes on investments, mortgage interest deductions, risk, and private mortgage insurance, among other elements of your financial life. An experienced financial advisor can run all of the numbers and conduct a complete examination of your unique situation.
The Pros And Cons
There are some pros and cons to each choice that go beyond the raw math. Liquidity is a significant pro for investing since you’ll have greater access to the funds in case of an emergency. If you put the money towards your mortgage, it’s gone, for all intents and purposes. The only way to get the money back is to sell your house or refinance your mortgage.
On the other hand, an advantage to paying down your mortgage is that your house will be paid off sooner. You will have a greater chance of being able to enter retirement without a mortgage, or at least have your mortgage paid off earlier in retirement. This lets you free up more of your money before your medical expenses start to build. If you invest, your mortgage will be another bill you have to pay while in retirement.
Another benefit of paying off your mortgage completely is decreasing your risk. Once you own your home free and clear, you never have to worry about a foreclosure or having your credit damaged by missed mortgage payments. However, you still have to pay your taxes and carry some risk of having a lien placed on your property.
Best Of Both Worlds
For some people, it may make more sense to choose a combination of these two choices. For example, if you have less than 20% equity in your property you may be required to pay private mortgage insurance, meaning you owe additional premiums on top of your mortgage principal and interest payments.
In this case, even if your mortgage rate is 5% and you can earn 6% on an investment, you may still earn a higher return on your money by paying down your mortgage. Once you pay it down to at least 80%, you free yourself of the need for private mortgage insurance and you can start investing, should you determine that is the ideal option for you.
What’s Right For You?
There are several factors to take into consideration when choosing whether to use your excess money to pay down your mortgage or increase your investing. No one strategy fits everyone, but at Harbor Wealth Management, our goal is to understand and explore your short-term needs, long-term goals, and risk tolerance to create custom strategies to help you pursue them. To learn more about how we can help you pursue the best return on your money in your specific situation, send me an email at firstname.lastname@example.org or call my office at 985-605-7185 and schedule a no-obligation conversation.
With nearly two decades of experience in the financial services industry, Jeremy Smith serves as a dedicated and knowledgeable financial advisor and the founder of Harbor Wealth Management. He specializes in serving retirees, pre-retirees, small business owners, and widows, providing a comprehensive array of investment management and financial planning services. Jeremy aims to serve his clients as a financial guide who is here for their every need, helping families find lasting solutions so they can focus on what matters most to them. To learn more about Jeremy, visit www.myharborwm.com or connect with him on LinkedIn.
Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. You should discuss your specific situation with the appropriate professional.