One of the longest-running debates in personal finance is the question of whether to use extra money to pay off your mortgage or invest.
3 Things to do Before Considering Either Option
Before you get aggressive on investing or paying off your mortgage you need to ensure your financial house is in order. Before choosing either option, you should have the following.
1. A fully-funded emergency fund
2. All your non-mortgage/high-interest debt paid off
3. Already be allocating at least 15% of your income to retirement savings
Once you have the financial essentials on lockdown, it’s time to decide which is better investing or paying off the mortgage.
Paying off your mortgage in 10 years rather than 30 years is extremely aggressive and the math still favours investing. The math would be even more favourable towards investing in a scenario where the mortgage was paid off in 15 or 20 years rather than 10 years.
The reason? Compound interest.
If you go the investing route, you get 30 years' worth of compound interest on your first monthly investment instalment.
If you pay the mortgage off in 10 years and then invest, you only get 20 years of compounding.
If you pay the mortgage off in 15 years and then invest, you only get 15 years of compounding. If you pay the mortgage off in 20 years and then invest, you only get 10 years of compounding.
The longer it will take you to pay off your mortgage, the more the math will favour investing over paying off the mortgage.
Your Mortgage Rate Makes a Huge Difference
I used a mortgage rate of 4% in this example. At this rate, the math is close when it comes to paying your mortgage off in 10 years compared to investing.
If your mortgage rate is locked in at less than 4%, the math would strongly favour investing.
If your mortgage rate is higher than 4%, the math would begin to favour paying off the mortgage.
So, which is better, paying off the mortgage or investing? It should be clear by now that the answer is, “it depends”. It depends on all the factors just discussed.
It’s less important which option you choose and more important that you find a way to increase your savings rate. How much money you save will be the determining factor of how much wealth you build.