Like many people, when you bought your house and got your mortgage loan, money might have been a little tight. Not only did you have the new house payment (including the new property taxes), but you also had to buy new furniture, right? But then, after a few years or maybe a new job, you started to have a little extra money and you’ve wondered whether it makes sense to pay extra toward your mortgage, or if you should invest the money. It’s a good problem to have, but there isn’t one right answer for everyone. It depends on you, your discipline, your risk tolerance, and your goals.
Should I Pay Off My Mortgage Loan Early or Continue to Make Payments?
There can be clear financial implications to making extra payments vs. investing the money, but the decision to pay off your mortgage early is not only a financial one. For example, depending on your personality and goals, the peace of mind from owning your home free and clear of a loan may be more important than coming out ahead financially by investing the money. Let’s assume you have an extra $500 per month to either invest or pay to the principal on your mortgage. Here are some factors to consider:
Effect of Compounding Interest Rates
If you invest $500 per month and earn a conservative rate of 6% in mutual funds, at the end of ten years you’ll have nearly $82,000. If you apply that $500 per month to an average mortgage loan over ten years, you’ll reduce the balance by a little more than $70,000 beyond what you would have made the normal payment. Obviously, you’ll be better off financially investing the money, and the amount you’re better off gets even better if you average more than 6% over the 10 years. But, in order to realize that benefit from investing, you’ll need discipline. When you apply the $500 toward the principal on your mortgage, that money is gone; you used it to pay down debt and you can’t use it for something else unless you refinance your mortgage. When you save or invest the $500, you have to avoid the temptation to use that money for another purpose, like a vacation. In addition, when you seek higher returns by investing your money, you may also subject those funds to downward movements in the market. Over the long-term, most people experience higher returns (rates of growth) in mutual funds, but there are times when the market goes down and your investment balance can drop. Lastly, there can be tax consequences of paying off a mortgage loan early. Under the current tax code, many people can deduct the interest paid on the mortgage loan for their primary home from their taxable income. If your tax rate is 25%, then the effective rate of a 4% mortgage loan becomes 3%. As you pay the principal balance down, you reduce the amount of the deduction. At the same time, there are tax consequences for investing money when you go sell the investments. When you sell, you pay capital gains taxes on the growth of your investment account above your deposits.
The Right Decision for You
Most financial advisors tell you to invest the extra money instead of making extra mortgage payments. On paper, they’re right. Over the long haul, you’ll usually be better off financially by investing over speeding up the repayment of a mortgage loan; especially in very low-interest rate environments. But before making a decision, ask yourself what’s important to you. Do you have the discipline to set that money aside and let it grow in the market? Can you handle the ups and downs of the market? Or, is it more important to you to pay off your mortgage loan in 15 or 20 years instead of 30, and have no mortgage payment? The right decision for someone else might not be what’s right for you.
Metro Credit Union | Best Home Mortgage Loans in Omaha, NE
Metro Credit Union Mortgage is the home lending side of Metro Credit Union. Buying your first home is a big step, but it doesn't have to be a scary one. The more you know about the home buying process, the more confident you'll feel about making these important decisions that will shape your future. When you're in the market for a home loan, you know you can trust your credit union to provide a great rate, great service, and all with fewer and lower fees. And, we've got you covered with a wide variety of lending options. Use our financial calculators for calculating a mortgage or refinance.
