By Brian Bloxom, ChFEBCSM
In the symphony of personal finance, one of the most puzzling notes to strike is the choice between paying down your mortgage or investing your surplus cash. It’s a financial decision that can resonate for years to come, echoing in your bank account and impacting your long-term financial well-being.
Leaving your extra funds sitting in a savings or checking account may not be the wisest choice, as the potential for growth through investments could be missed. The goal is to make sure they’re working for you. In this article, we aim to help you answer this age-old question: Should you allocate your excess funds toward chipping away at your mortgage or let your money grow in the world of investments? Read on for our insights and strategies to make an informed choice that aligns with your financial goals.
What Makes the Most Financial Sense?
When deciding between these two options, you first want to know which option can provide the greatest payoff. In this case, it’s your mortgage rate versus your expected investment return. You can calculate some rough estimates to evaluate which decision would make more financial sense.
Let’s consider an example. Say your mortgage interest rate is 5%. If you estimate that, based on your risk tolerance and time horizon, you can expect an investment return of 4%, it would make more sense to pay down your mortgage. Otherwise, you’re potentially throwing away 1%. However, if you are an aggressive investor and believe you could earn 8% on your investment, it would make more sense to invest.
This may sound simple on paper, but there are a lot of factors at play. And as we all know, even the best of predictions aren’t set in stone. It’s important to run a thorough analysis and factor in taxes on investments, mortgage interest deductions, risk, and private mortgage insurance, among other elements of your financial life. An experienced wealth advisor can run all of the calculations and do a complete analysis of your unique situation.
The Pros and Cons of Each Option
There are some pros and cons to each that go beyond the raw math. Liquidity is one big pro for investing. You’ll have easier access to it in case of an emergency. However, if you put the money towards your mortgage, it’s gone, for all intents and purposes. The only way to get the money back out is to sell your house or refinance your mortgage.
However, an advantage of paying down your mortgage is that your house will be paid off sooner. You will have a greater chance of being able to enter retirement without a mortgage, or at least have your mortgage paid off sooner during retirement. That way you can free up more of your money before your medical expenses start to build.
Another benefit of paying off your mortgage completely is decreasing your risk. Once you own your home free and clear, you never have to worry about a foreclosure or having your credit damaged by missed mortgage payments. However, you still have to pay your taxes and homeowners insurance and carry some risk of having a lien placed against your property.
Choosing a Combination of the Two
For some people, it may make more sense to choose a combination of these two options. For example, if you have less than 20% equity in your property, you may be required to pay private mortgage insurance, meaning you owe additional premiums on top of your mortgage principal and interest payments.
In this case, even if your mortgage rate is 5% and you can earn 6% on an investment, you may still earn a higher return on your money by paying down your mortgage. Once you pay it down to at least 80%, then you free yourself of needing private mortgage insurance and then you can start investing, should you determine that that’s a more appropriate option for you.
Work With a Trusted Professional
This article serves as a broad overview of the decision-making process, but many other considerations should be taken into account before choosing a path and moving forward. With a specialization in serving retirees and pre-retirees, we at Sentinel Wealth Partners have had the privilege of helping many people make informed financial decisions just like this one.
To understand how we can assist you in determining the highest return on your investments tailored to your unique circumstances, please don’t hesitate to reach out to us. Call our office at 703-832-0164, send an email to [email protected], or use our online calendar today.
About Brian
Brian Bloxom is an Independent Financial Advisor, Chartered Federal Employee Benefits ConsultantSM (ChFEBCSM) and Chartered Retirement Planning Counselor℠, CRPC® professional with 25 years of experience in financial advising. He founded Sentinel Wealth Partners to serve retirees, individuals approaching retirement, and individuals managing complex retirement plans such as company plans or federal benefits plans. His expertise and dedication to helping his clients achieve their goals make him a trusted resource that will help you feel confident in your customized retirement plan. Brian’s mission is to be available to his clients—all the time. He’s here to solve your problems, relieve your anxiety, and give you optimism for retirement. Because ultimately, your retirement should be about well-deserved enjoyment, and not about stress or anxiety. When he’s not working, you can find Brian spending time with his wife, Jessica, and their two sons, Spencer and Preston. He enjoys coaching soccer, serving in his community, golfing, and relaxing at his vacation home at Lake Anna, VA. To learn more about Brian, connect with him on LinkedIn.
Disclosure
“Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Sentinel Wealth Partners and Cambridge are not affiliated. Sentinel Wealth Partners is not engaged in the securities business. Cambridge does not offer tax or legal advice.”