Written by Prio Wealth Advisor, Kelley Ellis
and Prio Wealth Relationship Manager, Robert Devinney, CFP®
Collectively, Americans hold about $9.44 trillion of mortgage debt, the largest amount of consumer held debt in the country. It may be natural to want to pay down your mortgage as quickly as possible, especially if retirement is on your horizon. But does accelerating your mortgage pay down strategy come with an opportunity cost? Would investing incremental savings prove to be more fruitful for your future financial scenario? While these may be challenging questions to quickly answer, identifying your financial priorities and putting a plan in place to achieve these priorities will help you gain the clarity and confidence in your decision.
First Step: Follow the Math
Several financial and non-financial factors come into play when quantifying the pros and cons of either accelerating your mortgage pay down or investing. The largest factor in making this determination comes down to rates. More specifically, there are two types of rates to consider: the mortgage interest rate and the investment rate of return.
Can you earn a higher rate of return by investing the extra cash than your mortgage interest rate? If yes, investing the money might be a good option for you. If not, perhaps paying your mortgage early is more suitable. Below we illustrate two scenarios to point this viewpoint into perspective
The Numbers When You Pay Off Your Mortgage Early
Suppose you take out a 30-year mortgage of $300,000 with a fixed interest rate of 4.06%. This would likely lead to a minimum monthly payment of ~$1,443 over the course of the loan. By the end of your mortgage date, your total loan payments would be $519,571, of which ~$219,351 is interest paid to the lender. Not insignificant!
Perhaps you decide to add an incremental $500 to your monthly mortgage payment. In doing this, the math implies you would be able to pay off the terms of the $300,000 mortgage in 18 years, and reduce the interest paid over the course of the loan to ~$125,518. It’s a measurable difference in interest paid!
Another strategy that can be used effectively is a lump sum payment during the life of the loan. For example, if after five years you put $100,000 of liquidity towards your mortgage repayment, your mortgage term would be reduced to an additional 12.5 years. In this scenario your total interest paid would be ~$100,192.
The Numbers if You Invest
Let’s say you take the extra $500 monthly contribution from the second example above and invest it in a taxable investment account. We will assume the monthly contribution was invested in the S&P 500 Index Fund with an average annual return of 8%. If you saved and invested the $500 each month for 29 years, you would have a total of $174,000. By saving and investing, rather than paying down the mortgage a bit faster, you could have created more wealth — all while paying down your mortgage.
In the third example, we will consider investing the $100,000 into the S&P 500 Index Fund rather than paying off your mortgage. Over the course of 23 years, if fully invested at an average annual return of 8%, your taxable investment account could be closer to $800,000. This outcome would be yield both savings and equity in your home in over the length of the loan.
But it’s Important to Go Beyond the Numbers: Non-Financial Factors to Consider
Now that you have seen the numbers, it is important to put into perspective your priorities. For instance, if you are debt-averse, you might want to pay off your mortgage early so that you no longer have to worry about how much you owe and when you owe it. It is important to determine what is more important to you: living a debt-free life or maximizing your retirement savings early.
Other factors you would want to consider include:
- Do you plan to live in the house forever?
- Do you want to build more equity in your home?
- Do you want to build a liquid investment portfolio?
- Do you have high-interest loans like credit card debt besides your mortgage debt?
- Do you have at least 3-6 months worth of expenses saved in your emergency fund?
Let Prio Wealth Help You Plan & Strategize
With many financial and non-financial factors involved in this decision to pay off a mortgage early, it’s not typically a straightforward decision to pay or invest. At Prio Wealth, we work with our clients to develop a priority-based wealth management strategy customized to their financial situation. Please contact an experienced Prio Wealth Advisor to discover your priorities and gain confidence, clarity, and control of your financial life.