Mortgage Blog
Making Sure your Mortgage Fits
Breaking Down the Math and Potential Opportunities
October 13, 2022 | Posted by: Simon Lyn
Breaking Down the Math and Potential Opportunities
You’ve probably dreamt of the day your mortgage is finally paid off and you don’t have to pay anymore interest. Perhaps you’re using any extra savings to make larger payments whenever possible. But, if you’re looking to make the most out of those savings, there are other options worthwhile considering.
Say you have a 30-year mortgage of $200,000 with a fixed rate of 5.14% (as of Oct. 12th 2022). Your monthly payments would be $1,084 (not including taxes), and you’d spend a total of $110,179 in interest over 30 years. Now, let’s say that you’re able to pay an extra $300 per month toward your mortgage. You’d end up removing about 11 years from your repayment period, saving $80,114 in interest.
But, what if you were to invest that extra monthly $300 into an index fund instead? Historically, the S&P 500 index returns an average of 10% annually. To be extra conservative, let’s assume a return of 8%. After 19 years, you would have gained $160,780. That’s double your potential interest savings. In fact, after 19 years, you’d have about $109,431 left on your mortgage. If you decided to pay your mortgage off early, you could use your investment funds and still have $51,349 left.
But let’s not get ahead of ourselves, here. This scenario might sound like a no-brainer to go with, but there are several other factors to take into consideration.
Pros and Cons of Paying Off Your Mortgage Early
From a financial perspective, it’s usually best to invest your money rather than pay your mortgage off faster. However, life isn’t just about cold, hard numbers.
Pros:
Interest savings: You could save thousands of dollars in interest payments. When you pay your mortgage early, those interest savings are a return on your investment.
Peace of mind: If you don’t like the idea of debt, early mortgage repayment could ease your burden. If you experience a financial emergency, a paid off home means you don’t have to worry about missing mortgage payments and potentially losing the home.
Build equity: Repaying your mortgage faster builds your home equity faster. This helps you qualify for refinancing, which could save you even more money versus other sources of funding, like taking out loans. You could also leverage your equity by taking out a home equity line of credit (HELOC), which you can use for additional investments.
Cons:
Opportunity cost: Paying off mortgage faster means you can’t use your extra money for other financial goals. You may be paying off your mortgage early at the expense of growing your retirement savings or other higher return opportunities.
Tied up wealth: Property is an illiquid asset, meaning you can’t convert it to cash easily. If you faced a financial emergency or had an investment opportunity, it would take longer to access the required cash.
Pros and Cons of Investing Your Extra Cash
Pros:
Higher returns: For years, stock market returns have been higher than mortgage rates, meaning you could gain quite a bit from the difference.
Liquid investment: A home ties up your wealth, having your money in stocks or other market investment means you can easily sell and access your money if needed.
Cons:
Higher risk: There is more volatility in the stock market than in the housing market, so you should be sure your investing timeline is long enough to account for this.
Increased debt: Choosing to invest your money may not be the best option if you don’t like the idea of having debt. Until your mortgage is repaid, you don’t actually own your home—the bank does.
Get the Best of Both Worlds: Refinance and Invest
If you’re still on the fence about which option is best, you may not need to choose between early mortgage repayment and investing. You can take a two-pronged approach to reducing your debt and growing your wealth by refinancing and using those funds to invest. This allows you to spend less on your mortgage overall while still benefiting from higher returns of the stock market.
