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Extra Mortgage Payments Versus Investments: Which Is The Right Move? 2comments
As my wife and I begin the process of finding and buying a home, we repeatedly find ourselves investigating various aspects of home ownership. Right now, we’re in a situation where we are able to save and invest far more each month than we will be spending on a home mortgage in the price range we’re looking at, which means that after we move, we’ll still have a few hundred extra per month (yes, even after figuring liberally for all sorts of home ownership costs) to either invest or to put towards paying off our mortgage faster. We have little interest in buying a home that will put us in debt up to our neck.
I found that this article at bankrate.com does a great job of spelling out the pros and cons (in general) of extra mortgage payments versus investments, but the conclusion leaves something to be desired. In short, they dodged the question by saying that they’re both good.
So my wife and I sat down, deconstructed that article (and several others), and came up with a brief questionnaire that can help you decide whether or not you should take extra money and invest it or put it towards your home mortgage. It’s a series of five yes-or-no questions, so let’s play along at home!
1. Are you a conservative investor (i.e., are you uncomfortable in the stock market and prefer to earn less and keep your principal safe)?
2. Are you planning on living in the home for longer than five years?
3. Do you not expect significant acceleration on your income?
4. Are you in a low tax bracket (25% or less)?
5. Are you within fifteen years of retirement?
The more “yes” answers you have, the better the case is for putting money into your mortgage rather than into an investment. In general, if you are a conservative investor, if your life is highly stable, and you’re approaching retirement, you’re better off paying off the house. On the other hand, if you’re young and looking at moving in the near future, invest the money.
For us, we made the decision to put more money into our mortgage. The big reason is that we’re conservative investors. We also plan on living in the same area for a long while and we want to start building our dream home when we’re in our forties at a point when we plan to have our house paid off (we’re going to likely get a 15 year mortgage and still make extra payments).
Are you currently maxing out your retirement accounts? If not, then you may want to reconsider your decision. One of the most powerful tools that you can use to build wealth is a combination of mortgage deductions and retirement savings.
Here is a link to a white paper with a very technical analysis of the issue: http://www.chicagofed.org/publications/workingpapers/wp2006_05.pdf
As a mortgage broker and financial planner, I believe that most people would be better off investing than paying down the mortgage. Why? Even if you are a conservative investor (say you are earning 6% in a mix of cash and bonds) with a fixed mortgage at 6%, investment is preferable because of the tax advantage of the mortgage….even if you are in the 10% tax bracket.
Furthermore, what good does equity in your home do? Once you have a 20% equity position, you are eligible for the most attractive financing available. Any equity beyond that is locked into the home, unavailable to you should you have a financial crisis (sudden unemployment, medical issue, etc). If and when that happens, you have to approach a broker and borrow that equity back on their terms, or face selling your home or losing it to foreclosure.
IF and only if you are able to save those funds (not spend them, as do most Americans), then you are almost definitely in a better position by investing (even in a non-tax-advantaged account) than prepaying your mortgage. Here is another document worth reading – a much easier read than the white paper above: http://www.cmpsinstitute.org/images/HowtoSafelyManageHomeEquity.pdf
Best of luck!