Buying a home is often considered one of the best long-term investments that someone can make. When you do purchase a home, it will likely require that you take out a mortgage to finance the vast majority of the purchase. Eventually, you may find that you have extra money each month that could be used to either continue to pay down the mortgage balance each month even more or could be used to invest.
Paying down debt early is one of the financial goals people aim for each year, while some people think making an investment could be the smarter move. Well, when you have to decide between payoff mortgage early or invest, there are several factors that should be taken into consideration when determining whether or not you should use the extra money to pay down the mortgage or invest. Here are some of them.
When someone is wondering should I pay off my mortgage or invest, the first factor to take into consideration is whether there are any prepayment penalties. While these types of penalties are more rare nowadays than in the past, there are still many people who have mortgages that contain prepayment penalties. If you have a prepayment penalty that you have to pay, it could dilute the potential return on investment that would come with a pay down of your mortgage.
When it comes to determining whether you should pay off your mortgage or not, you should also consider what your future plans are. When thinking about whether is it better to pay off mortgage or invest, you will need to think about whether you want to leave debt for your heirs. If you plan on passing down your home to your children or other heirs, you likely won’t want them to be obligated to pay the mortgage. In these situations, paying off the mortgage could make more sense.
Determine True Cost Savings
Before determining whether you should pay off mortgage early or invest, you need to understand the true cost of your decision to pay off the mortgage early. The main advantage of paying off a mortgage early is that you will get to avoid paying additional interest over the course of time. To understand what the true benefit of this is, home loan repayment calculator can help you calculate how much you can save when you make extra payments. These calculators will be able to provide you with a variety of valuable information to help you make a better decision including telling you how much money you would save, how much faster you will pay down your loan, and when you could ultimately be debt free.
Investment Return Potential
When you are trying to determine whether you should invest money or pay off mortgage, you also need to factor in the investment return potential. You pay off a mortgage or any other type of that, you are essentially earning a return on investment that is equal to the interest rate on the loan. Since mortgage rates have been very low over the past few years, this means that you essentially will be earning a ROI of under five percent. This return on investment may seem very low compared to other investment opportunities. For example, investing money in the general stock market has typically provided an investor with returns in excess of 7% on average.
One of the most important factors to consider when you are thinking should I pay off my mortgage or invest the money is to consider your risk tolerance. One of the main advantages of using your money to pay down a mortgage or other type of loan is that it will provide you with a guaranteed return on investment. While the return on investment may be lower than what you could achieve by investing in the stock market, there is no ability for you to lose this investment.
However, when investing in the stock market you could end up losing a significant amount of your capital if the market and investments do not go in your direction. If you are not in a position to take this risk, paying down your mortgage early could be the better decision.
Finally, you need to consider tax implications of your decision. If you itemize your deductions, mortgage interest you pay is deductible. If you pay down your mortgage balance, you will lose this tax benefit. Furthermore, if you invest in the markets and hold your investments for more than one year, you will only be taxed at the capital gains rate, which is often lower than your personal tax rate.