If you have extra money, do you typically put that towards an extra mortgage payment that month? Or do you invest it? Which option will save you more money in the end?
After all, there is undeniable comfort and relief to knowing that your home is truly yours. But with mortgage rates at roughly 5% right now, is this still the best way to spend your money?
Prioritizing Debt & Mortgage Payments
According to an article in the New York Times the answer is – probably not.
If you have a higher interest rate, like around 7-8% or more, making extra payments will definitely save you money in the long run because it could be hard to beat that rate with investment returns. But if your interest rate is only 5% or lower, then you might be better off keeping that money more liquid.
But let’s rewind for a second here. Before investing in anything (i.e extra mortgage payments or stocks and bonds) it’s important that you have all unsecured high interest debt paid off. When given the option to choose between paying extra on your mortgage or paying on a credit card – the answer should be to pay off the credit card.
If you have quite a bit of debt in say credit cards, car loan, mortgage, and student loans, the best thing to do is to list them in order by interest rate from high to low. Then, start paying off the debt beginning with the highest interest rate first. This way, you minimize your overall cost of borrowing.
Investing Extra Money: the Benefit of Having a Low Mortgage Rate
But if you’re part of that rare group who’s ahead on all of their finances, and just have that extra money to either pay on the house or invest, here are your options. After you save a hefty emergency fund and max out your 401(k), the Times article suggested beginning investments such as a Roth IRA (Individual Retirement Account) or Vanguard Wellington.
So why shouldn’t you pay off your house?
Well, if you have a 5% mortgage rate, Times explained that you are actually only paying an interest rate of roughly 3.25% because of the tax deduction you can claim on it. So if you invest the extra money towards anything that has a higher return than roughly 3.25%, then you are making more money than just paying off your loan early.
Take the Vanguard mutual fund for example. This holds about 65% stocks and 35% bonds, and over the past 10 years earned an average annual return of 6.15% – that’s almost 3% more profit!
Times suggested the Roth IRA account because if you’re concerned about paying taxes on the profit, accounts like this can help with that worry. For more information, be sure to check out the original article: When Not to Pay Down a Mortgage.