Provided by Terry Garland and written by Indigo Marketing Agency, a non-affiliate of First Allied Securities, Inc.
How many times have you heard that mortgage debt is good debt? We know that debt reduction is a healthy financial goal, especially when it comes to high-interest debt such as credit cards or student loans. And we also know that it’s important to minimize debt so that when we reach retirement, we aren’t using our precious nest egg to pay off loans. But do these principles apply to your mortgage? Should you throw every extra dollar toward your mortgage or should you invest that money 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.
Which Will Give Me The Most Growth?
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, based on your risk tolerance and time horizon, you can pursue an investment return of 4%, 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 toward your mortgage, for all intents and purposes, it’s gone. 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.
A Bit Of Both
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 Golden Capital Management, our goal is to provide customized solutions that meet your needs and get you closer to reaching your goals. To learn more about how we can help you pursue the best return on your money in your specific situation, call us today at (515) 226-0115 or email info@garlandandassoc.com.
About Terry
Terry Garland is the founder and CEO of Golden Capital Management with more than 25 years of industry experience. He works with individuals, small-to-medium-sized businesses, and medical professionals, including physicians and dentists, allowing them access to a wide variety of specialized services and investment vehicles to fit their specific needs. He graduated from Drake University and attended the Wharton School at the University of Pennsylvania and is a registered principal. With offices in Des Moines, Iowa, and Carlsbad, California, he serves clients across the country. Learn more by connecting with Terry on LinkedIn.