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Paying off mortgage early VS. Saving

I used to visit a small forum that discussed ideas and strategies in personal finance. One of the topics that got a little divisive was the issue of paying off your mortgage early. A majority of the people who argued for paying off mortgages early were well-off white collar workers with extra cash to spend. They would ask the question with a predisposed position and really wouldn’t stand for having their minds changed. We are told to pay off debt first and invest later, and they stood by that.

But why not do both?

I was in the minority in this debate and I argued for something different. My stance was this: If you are looking for added comfort and a little less weight on your shoulders, work to pay off your mortgage early. If you are looking for the best investment decision, invest the excess money.

Before I present my case, let me present an example.

John doe has $100,000 left of mortgage to be paid off at 5%. He expects this to be paid off in 10 years and 2 months. He is paying $1060 a month but has extra cash to spend. He decides that he can pay out $3,000 a month, paying off his mortgage in 3 years. Doing this will save him $19,450 in interest over the life of the loan. Traditional financial planners would tell him that this is a wise decision. For most Americans, it is. But what is the better investment choice? Can John get a better return for his excess money by using it elsewhere? The answer is yes.

To compare and contrast investing vs. paying off mortgage early, let’s assume averages. The stock market has historically returned 10% to investors and therefore we will use that as our benchmark.

Paying off mortgage early:
-Savings in interest: $19,450
-Loss of interest writeoffs in tax season assuming a 30% tax rate: ($5,835)
-After John pays off the house, let’s assume he invests for the remaining 7 years that he would have been paying off his mortgage. He invests $3,000 in the stock market each month. After 7 years of investing his contribution at 10% would yield $375,691

Total cash at the end of ten years: $389,306

Investing excess cash
- John invests the excess $1,940 in the stock market instead of paying off his mortgage early. That equates to $23,280 a year in investments and once again we assume a 10% return.

Total cash at end of ten years: $408,125.57

Conclusion
John would have made almost $19,000 more by investing his money instead of paying off his mortgage.

Comments
The example was basic and interest rates are closer to 6% than 5% these days. However, It is a fundamental fact that using historical returns as a guide, you can make more money by investing your excess cash. Debt is not a bad thing to have if you can manage it.

What most people base their decision on is this: What’s safer?

I truly believe investing your money is safer than paying down your mortgage.

If you put all of your extra reserves into your home you are SEVERELY restricting your capital in the case of an emergency. In order to take care of a catastrophe or a dire medical need, you will need to BORROW against your home through a HELOC or you will need to refinance. Even worse, let’s pretend you lose a job in year two and cannot afford to pay even the MINIMUM amount of your monthly mortgage. You still owe the bank a monthly check, no matter how far in advance you are in principal payments!

Each person’s scenario is different. If you aren’t cash strapped and you are making your decision based on economics and rate of return, consider this article. It can help guide you in the decision making process.