Should I Invest My Extra Earnings or Pay off the Mortgage?
Pay Off the Mortgage or Increase Our Invest Holdings?
After years of hard work and effort building our financial base, we reached a point where we had some extra income that wasn't already spent by the time it came in (!). What to do? We realized we had to make a choice: work to pay off the mortgage on our home, or work to increase our investment holdings. Either one would take a while, but with a focused effort and time, they could be done. The question was which should we choose?
Should we work to pay off our home loan or invest in the market? Pay off the mortgage early or save? It was time to review our options.
Raise A Toast
If this describes you then congratulations! You've managed to plan for home ownership, qualify for a loan, and have some extra funds left over for investing in either mortgage pay-down, or some other form of investment. You've accomplished something amazing, and you're looking to elevate your game to an even higher standard. Nice work!
Before making a decision, you'll need to put your financial house. Have you checked all the boxes you need to create a strong foundation?
Cover Your Bases: Emergency Savings Account
Pay off the mortgage early or invest? Here's how we approached it...
First off, we reviewed our emergency account. Do you have an emergency savings account, enough to pay expenses for three months, six months or more? If the answer is no, then start saving and leave the extra mortgage payments for later.
Emergency accounts are for the loss of a job, unexpected medical expenses, and anything else that qualifies as a true emergency. Fixing the car is not an emergency; neither is a last-minute vacation purchased at a great price. The emergency fund is for a true emergency.
How long, realistically, would it take you to find an equivalent income? That's how long the emergency fund needs to last. If nine months seems an impossible goal, start with a three-month goal. If that's too difficult, go with one month or one paycheck. Put it in a savings account or money market, something you can liquidate instantly if you need to.
Hot Tip: Emergency savings are savings, not investment. Aside from a small interest increase, you are not in the business of "investing" your savings account in stocks or anything risky.
If people are losing jobs, it usually means the economy is struggling, and people are much less likely to be purchasing investments. That means your investment would be worth much less just when you need it most. Don't make that mistake!
Pay Off Other Debts
After you have a month of expenses in a savings account, start to pay off high-interest debts (credit cards, payday loans, perhaps a car loan) as soon as you can, while continuing to build up savings account. We made sure to do this FIRST, before putting money into investments or mortgage pay-down. If you have high-interest debt, you should ALWAYS pay that off before making other investments, or putting extra payments towards a mortgage. Credit cards, department store cards and payday loans are some of the highest - interest debts and should be paid off before you go any further.
Not sure what your interest rates are? Now is the time to look up the most recent statements on credit cards, payday loans, auto and other loans. Grit your teeth, chin up, open the envelope (if you haven't already), scan the first page and write down the interest amount.
Yikes! 15%, 18%, 21% or more is not unusual. That means for every $100 you owe, you pay an extra $18 every year to the company for the "privilege" of borrowing. That's assuming no late fees or other expenses, and only if you pay the amount in FULL that first year. If not you're paying interest year after year. Add missed payments, fees and other expenses and you are paying them a LOT of money to send you a bill in an envelope every month.
Smack those credit card and payday loan debts out of the park, and you'll be taking control of your financial life in the best possible way.
Pay off other debts, or have a payment plan in place: debts to family and friends are still debts and need to be paid off just like any other obligation. Do this FIRST, before putting money into investments or mortgage pay-down, and you'll feel a lot more confident about ups and downs in the future.
Final Tip: Matched Contributions
If we had been lucky enough to have an employee retirement plan providing matching company funds, we sure would have taken advantage. If the match is 100%, you are making a 100% return on your investment right from the top. Even a 50% match is excellent: for every $100 you invest, the company invests an additional $50 in the fund.
We also considered our diversification strategy. It's not a good idea to keep all your investment eggs in one basket, and if you work for the same company you are investing in, you've got a lot of risk in just one place. If you can, make a balance between the matching fund option and the need to diversify (mix up) your asset holdings. In our case, we also reviewed our charitable giving goals, to be sure our "diversification" included a giving plan as well as an investment plan.
Crunch the Numbers
All the bases covered? It was time to run the numbers.
First we asked our mortgage provider if they would accept prepayments to the mortgage balance. I made absolutely sure that payment would go to reduce the principle, not the interest! We requested and reviewed an "amortization schedule" to can view the finances and the timeframe. We were in luck! Two years of concentrated effort would allow us to pay off the principal, with no penalties or related fees.
Next, we compared return rates and risk. Our mortgage interest rate was 6.25%. Stock market investing could earn more, but then again it might not. Paying off the mortgage is essentially risk-free, whereas investments usually have some risk associated, as well as (perhaps) a higher payoff. We were on the line on this one.
Check In With Yourself
Mortgage pay-down or portfolio investment? We had a strong "gut" preference for paying down the mortgage. We found the security of knowing we would own our home is substantially more powerful than the idea of investing separately. If that describes you, pay off the mortgage and feel good about it!
Remember too that paying off your mortgage is a lower risk option. It may be well worth it, just knowing that your return is safe in the value of your home, instead of relying on the vagaries of the market.
Invest or Pay Off Mortgage? The Winner Is . . .
Pay off the home, or invest? We chose the former. It took us 18 months to burn through the remainder of our home mortgage, and we haven't regretted it for a second. If you're lucky enough to have this problem, do your homework and let me know in the comments what you decide to do. Good luck on an exciting decision!