Choices, Choices: Should I Pay Off the Mortgage or Invest?

A mortgage can be a substantial financial burden, and paying it off may be the first item on your financial to-do list. Competing with the desire to pay off the mortgage is your need to invest for retirement, your child’s college education, or some other goal. Putting extra cash toward one of these goals may mean sacrificing another. So, how do you choose? 

Opportunity Cost 

Deciding between prepaying your mortgage and investing extra cash isn’t easy because each option has advantages and disadvantages. You can start by weighing what you’ll gain financially by choosing one option against what you’ll give up.  

In economic terms, this is known as evaluating the opportunity cost. Making extra payments helps pay off your mortgage faster and reduces the amount of interest paid over the life of the loan. This reduction in overall interest paid could help you gain a lot of financial ground. The question becomes, would you be better off making additional payments towards your mortgage or taking those funds and investing them? 

Your opportunity cost is generally less than the interest rate you’re paying once you consider any tax deduction you may receive for mortgage interest. Once you’ve calculated that figure, compare it to the after-tax return you could receive by investing your extra cash. 

Other Considerations 

While evaluating the opportunity cost is important, you must weigh many other factors. The following questions may help you decide which option is best for you. 

• What’s your mortgage interest rate? The lower the rate on your mortgage, the greater the potential to receive a better return through investing. 

• Do you take the standard deduction or itemize your deductions? 

• Does your mortgage have a prepayment penalty? Most don’t but check before making extra payments. 

• Will you have the discipline to invest your extra cash rather than spend it? If not, you might be better off making extra mortgage payments. 

• Do you have an emergency account to cover unexpected expenses? Making extra mortgage payments now doesn’t make sense if you’ll be forced to borrow money at a higher interest rate later. Remember that if your financial circumstances change–if you lose your job or suffer a disability, for example–you may have more trouble borrowing against your home equity. 

• How comfortable are you with debt? If you worry endlessly about it, consider the emotional benefits of paying off your mortgage. 

• Are you saddled with high balances on credit cards or personal loans? If so, it’s often better to pay off those debts first. The interest rate on consumer debt isn’t tax deductible and is often far higher than your mortgage interest rate or the rate of return you’re likely to receive on your investments. 

• How will prepaying your mortgage affect your overall tax situation? For example, prepaying your loan (thus reducing your loan interest) could affect your ability to itemize deductions (this is especially true in the early years of your loan when you’re likely to be paying more in interest). 

• Have you saved enough for retirement? If you haven’t, consider contributing the maximum allowable each year to tax-advantaged retirement accounts before prepaying your mortgage. This is especially important if you are receiving a generous employer match. For example, saving 6% of your income and receiving an employer match of 50% on what you contribute (i.e., 3%), you could add thousands of extra dollars to your retirement account each year. Prepaying your mortgage may not be the best financial move if it means forgoing that match or shortchanging your retirement fund. 

• How much time do you have before retirement or until your children attend college? The longer your timeframe, the more time you have to grow your money by investing potentially. Alternatively, if paying off your mortgage before reaching a financial goal will make you feel much more secure, factor that into your decision. 

Conclusion 

Deciding where to put extra money can be a challenging decision, especially when you have competing priorities to think about. If you need assistance, your Sequoia Financial Advisor always available to help you make the best decision for you and your family.