Investing vs paying off your mortgage

[zetta]

A lot of people here talk about the strides they are making toward paying off their mortgage early. In a lot of cases you will actually come out ahead by investing that money regularly in a mutual fund instead.

Here is a calculator I found that will do a comparison for you (it takes the interest tax deduction into account.):

http://www.hughchou.org/calc/prepay_v_invest.cgi

In my case, if I choose a very conservative 7% return on my mutual fund, and look at either paying an extra $200 on my mortgage every month or investing that $200, my loan will take 4 years longer, but my fund will be worth about $123k -- $20.7k more than the interest saved.

(One assumption this calculator makes that I disagree with is that I will make an extra investment each year equal to the taxes I saved due to having a higher interest deduction. I think this is unlikely. In my case these investments add up to $13.3k.)

If I assume a return of 10% (which according to Common Sense on Mutual Funds is an index fund's long-term historical return), my fund will be worth $160k, $59k more than the interest saved.

I have almost enough in liquid assets to pay off my mortgage, but I won't be doing it. I believe in the long run I will come out far ahead by keeping that money invested. (Another calculator from the same site, http://www.hughchou.org/calc/payoff_v_borrow.cgi, says I will -- to the tune of $292k at 7% return, or $833k at 10%!)

Another advantage of investing vs prepaying is that a mutual fund is liquid enough to act as a backup emergency fund, whereas once you've made a prepayment you need a home equity loan to tap those funds.

[sweeps]

Your logic is good, but understand that the members on this site tend to be very conservative. They enjoy the security of being debt free and having "money in the bank" so to speak.

Using credit cards for reward points and 0% balance transfers also makes sense from a financial perspective, but there is a perception of risk involved that keeps a lot of people from doing it.

[PauletteGoddard]

Thanks for the link to the investing vs. paying off mortgage. I had wanted to pay off my mortgage in seven more years, and found that if I can swing somehow a 6.5% rate, and invest $500/month, I can do exactly that, and faster than directly paying the mortgage.

[zetta]

I'm surprised to hear that investing in mutual funds might be considered too risky for the members of this site -- don't most of us have our 401k's and IRA's in mutual funds instead of CD's? The danger of inflation erroding away the purchasing power of your investment is also a risk that you take by being too conservative. Assuming you have 10-30 years left on your loan, an no-load, low-cost index fund should be a reasonably safe investment.

[PrincessPerky]

I don't think it is a risk thing, it is a debt thing...those of us who hate being 'beholden' to others don't see a mortgage as..working money, I see it as a debt that aught to be paid ASAP.....

I shouldn't say we, that is just my take on it..even were they amount amazingly significant I would still opt for paying off my house, owning outright the roof over my kids heads...

Might not make the most sense mathmatically, but it is not a math qustion, it is my home....

Though I am glad you posted the math. I just wanted to defend my 'wuss' factor

[pearlieq]

Originally Posted by zetta

I'm surprised to hear that investing in mutual funds might be considered too risky for the members of this site

Not all, but enough to notice.

I personally agree with the logic stated, but may still choose to pay off the mortgage a little early, mostly for cash flow reasons.

[scfr]

Believe it or not, I was thinking about this very topic while walking the dog today ...
I'm one of those who paid of my mortgage early, and tho' that house has been sold and I am in "transitional housing" (renting from a friend) I will be paying for my next house with cash.

This is a bit hard to explain, but I will try my best ... I know this is going to sound cheesy, but I am speaking from the heart and from personal experience.

Paying off the mortgage early is not simply about the percentage you are paying on your loan vs. what you could make investing. It can have a really huge impact on your entire life.

Having no mortgage is really about freedom, a sense of security, and a huge boost in confidence. Obviously, this translates in to psychological benefits. But it can also translate in to unexpected financial benefits.

It may mean being able to cancel the term life insurance or raise the deductible on your homeowner's insurance. It may mean reduced health care or counseling costs due to the reduction in stress just knowing the house is paid for. And the big decrease in monthly fixed expenses may be just what it takes for you to finally decide you can walk away from the job you don't like very much but that pays the bills, and go out and start your own business doing something you love. [And as we all know, doing something you love often translates into increased financial success.]

Don't get me wrong ... I do understand that keeping the mortgage makes sense for so many people and I would never fault anyone who looked at the numbers and decided to keep it. But for some of us, it's about much more than just the numbers.

[creditcardfree]

If I had a paid for house, I would not borrow on it to invest in taxable mutual funds at a higher rate of return. Just too risky for me. I would take money that I no longer paid to mortgage and invest after the house was paid off early.

[Scanner]

I think there is a compromise here between either/or.

Most people, when they invest, put X amount into stocks and X amount into bonds. The bonds are considered the safe vehicle for investing, protecting your principal better over the long haul.

Why not instead, place X amount into stocks, forego the bonds and just send that amount towards your mortgage? It's a guaranteed 6.5% return - any tax benefits you receive by losing mortgage interest.

I think that's a great compromise - you can even elect to put your investments into something more volatile and risky and get a better return since you are doing a safe thing and paying down debt. Like investing in an emerging markets fund, maybe technology fund, some high risk investment. You obtain diversification by paying down the mortgage.

[tinapbeana]

when and if i get into the position to pay my mortgage earlier, i hope to do so. i agree with a previous poster, for me it's not about the numbers. it's more a situation of what i have to have to live, and that is food water and shelter. should something truly unfortunate and disasterous happen, having my house paid for will take care of 2 of those needs: shelter and a place to grow food. almost like the ultimate emergency fund, if you will...

[pearlieq]

Originally Posted by Scanner

Why not instead, place X amount into stocks, forego the bonds and just send that amount towards your mortgage? It's a guaranteed 6.5% return - any tax benefits you receive by losing mortgage interest.

That's an interesing idea. I had never thought of it that way.

[lieweheksie]

conservative- not so sure
for me my home is not an investment vehicle- it is my home, my sanctuary and my security- i paid off the mortage on our 1st house in 7 years- we moved 2 years later due to a worsening crime situation( i live in SAfrica)-we now have a small mortage thanks to having the equity of the 1st property-( we do have access to all additional funds paid in) i will not borrow agaisnt my house if I can possibly help it- do that on a 2nd properrty but not your home. I want to pay this one off as fast as possible- yes i could make more money investing- maybe- the stock market moves up and down but i like the security of owning my own home. i still invest in mutual funds and retirement funds and have an EF
Myself and a friend were thinking of investing in this one financial services company until the guy doing the presentation said that you did not need to worry about where to get the money- you could just borrow against your house- eek -we ran for the hills

[MonkeyMama]

Well zetta, think it is wise advice. Surprised it is met with such negativity.

I go back and forth with this so I think overall I land with Scanner. I think a little bit of both is good. Of course I do not plan to prepay the mortgage until many other goals are met first. & so in a way that is where I land. I think it is the last thing I need to do to find financial independence. & by the time get there I may likely have more money in the bank than my mortgage, making a decent return. & at that point I probably would not pay it off.

In the meantime I truly do regret the years we paid it off more aggressively. not all of them - I do not regret when we had a 15-year mortgage before kids. But since then money has been tight and I Continued to pay down the mortgage faster. I regret that now, but I think I have my priorities better set up financially now. Retirement first, then cash and investments, and then pay off the mortgage.

What is better financially depends greatly though on many factors. When the time comes will depend on our tax rate, interest rates, the stock market as a whole, etc., etc. If the stock market was down I would be more likely to invest. If interest rates were down we may refi back to 15-year mortgage. If our tax rate is very high we may prefer to pay the mortgage than generate more taxable income. Depends depends depends.

[Ima saver]

Of course, I am a lot older than most of you. When I was young, all I could think about was having a paid for home. I didn't know anything about investing or mutual funds. I got my house paid off at a young age and I am glad. I have had 3 other homes since then and they have always been paid for with no mortgage. When we built our second home, I started reading up on mutual funds and finally took the plunge to start investing. I started with $50 a month in american century Heritage back in 1988. I still have that fund. I find a lot of piece of mind knowing that if my husband lost a job or died, I would not have to worry about making house payments.

[scfr]

zetta - Great thread! I think this one topic more than any other shows that there is no "one size fits all formula" when it comes to finances. It's clear there are those of us for whom paying off the mortgage early was one of the best things we ever did, while there are those for whom keeping the mortgage is the best thing to do. Finally, each person must decide what is right for them.

[Scanner]

Thanks for the compliment.

I can't remember but there was a discussion somewhere on paying down your mortgage early. Something like if you add an extra $100/month, you save 7 years. Add $200/month, you save 8.5 years.

It got ridiculous after awhile, like adding an extra $2000/month only saved 10.5 years or something.

For paying down mortgages early it seems like a little extra is the best.

You know, we just do the equity income accelerator where they take out 2 1/2 payments instead of one per month. I beleive it has shaved about 4 or 5 years off of our 25 year mortgage doing that alone. I can't beleive how much that has worked - that was my wife's idea and I'm glad we did it.

[kv968]

Originally Posted by Scanner

You know, we just do the equity income accelerator where they take out 2 1/2 payments instead of one per month. I beleive it has shaved about 4 or 5 years off of our 25 year mortgage doing that alone. I can't beleive how much that has worked - that was my wife's idea and I'm glad we did it.

You should make sure the extra 1 1/2 payments are being applied to the principle and not just as extra payments.

[MonkeyMama]

Originally Posted by Scanner

Thanks for the compliment.

I can't remember but there was a discussion somewhere on paying down your mortgage early. Something like if you add an extra $100/month, you save 7 years. Add $200/month, you save 8.5 years.

It got ridiculous after awhile, like adding an extra $2000/month only saved 10.5 years or something.

For paying down mortgages early it seems like a little extra is the best.

You know, we just do the equity income accelerator where they take out 2 1/2 payments instead of one per month. I beleive it has shaved about 4 or 5 years off of our 25 year mortgage doing that alone. I can't beleive how much that has worked - that was my wife's idea and I'm glad we did it.

Yes for us it would be an extra 1.5 payments a year would minimize our payments, while maximizing how fast it will be paid off. I can't really see paying much more than that if I feel I could invest it well and make a better return.

But I still regret making those extra payments when money was tight. But on the flip side I don't see the point in paying much more than that extra...

A good point, something I weigh heavily in how fast we prepay.

[scfr]

Okay, I'm in the mood to stir things up a bit .....

In this weekend's Personal Finance section of our paper, there was an article that laid out some numbers on renting vs. buying a house. They explained that if what you are looking to do is maximize the return on your investments over time, using historical returns on housing vs. the stock market, it is better to rent instead of buy and invest your money in the stock market instead.

So, for those who said they would not pay off their mortgage early because they can get better returns from the stock market, why not sell your house, move in to a rental, and invest the proceeds in the stock market?

Yes - I know that there are variables other than return such as the tax write-off for mortgage interest, etc. But what the article made very clear was that for the average person in the average tax bracket, homeownership was the better investment only for the first few years, and then the scales tipped in favor of renting and investing in stocks.

Don't get me wrong ... I'm not suggesting that anyone actually do this! [I am one of those who paid off my mortgage early and I'll be buying my next home with cash. I'm just wondering, if the numbers are what really matter, how do you justify owning?]

[Ima saver]

I think everybody should read the book, "Banker's Secret" by Marc Eisenson.