This information is provided by our friends at Pentagon Federal Credit Union (PenFed).
It’s hard not to feel a pang of jealousy when a friend or family
member pays off their mortgage early. Debt-free living while owning your
home free and clear—what a fantastic feeling that must be. Meanwhile,
you’ve been chugging along at your investments, and while you believe
your strategy is sound, you sometimes wonder if you should you have
chosen to knock out your mortgage first.
The truth about choosing between paying
off your mortgage or investing your money is that personal choice can
play as crucial a role as many financial factors. There are plenty of
hard and fast rules about financial goals you should take care of before
paying off your mortgage, but once you’ve taken care of those factors,
you’ll find the payoff versus investment choice isn’t as clear.
Before considering a payoff
You’re almost certainly getting ahead of yourself if you’re
considering investing or paying off your mortgage before you’ve taken
care of these crucial financial goals:
- Pay off high-interest debt. Even the most
successful investors aren’t likely to earn more from their investments
than they’d pay out on high-interest credit card and other debt. It
makes no sense to try to save money while interest is eating you alive. Pay off your debts.
- Build your emergency fund. Everyone needs a good three to six months’ worth of income in the bank to take care of the unexpected. Make sure your rainy day fund is solid before beginning any investment or payoff plan.
- Make the maximum contribution every year to any 401(k) or other retirement plan
for which your employer offers to make matching contributions. You get a
secure, easy way to save money, and your employer gives you extra money
on top of that—that’s what they call free money. Don’t pass that up.
- Make the maximum annual contributions to other tax-deferred or tax-free retirement savings plans and IRAs. Here’s a chance to lower your yearly tax obligation; take it.
- If you’re planning to help pay for college for your children, find more tax-deferred savings in college savings plans like a 529 college account or a Coverdell IRA.
Once you’ve taken care of the financial basics listed above, you may
be ready to consider investing or paying off your mortgage. First,
though, you need to know how much your mortgage interest is actually
costing you. Remember that if you’re deducting your mortgage interest on
your income taxes, you’re effectively lowering your mortgage rate. If
you’re only paying an effective 3% to 5% on your mortgage, it will
probably be quite feasible to out-earn that through smart investing.
If it makes more sense for you to claim the standard deduction on
your income tax, though, you won’t be deducting your mortgage interest
and it might not be as easy to outpace mortgage interest paid.
Would paying off your home mean pulling money out of your savings?
Don’t sacrifice your security just to get rid of that monthly payment.
You never know what might happen in the years ahead, and you certainly
don’t want to sacrifice the headway and gains your retirement savings
are already earning.
If you’re already set with enough money to make a sizeable
investment, you could generate enough returns to cover your monthly
mortgage payment. This smart strategy leaves your savings nest egg
intact as investment principal while still painlessly covering your
Making the right choice
Financially speaking, the right choice between investing or paying
off your mortgage is a matter of which provides the highest return after
taxes. In general, investments almost certainly outperform mortgage
interest over the long haul—but investing does carry an unavoidable
element of risk, and paying off your mortgage represents a sure thing
with no risk attached.
Getting rid of those pesky monthly mortgage payments increases your
financial freedom and gives you more control over your monthly cash
flow. And you may find that you simply cannot put a price on the
emotional benefits of owning your home debt-free. The peace of mind that
comes with knowing the financial ups and downs of life will not affect
your home can be priceless.
The right answer for most people is a financially savvy decision that
factors in your personal feelings about debt, ownership, cash flow, and
risk. PenFed can help you get started plotting your course no matter
which route you choose: investing for the future with PenFedInvest, or refinancing your mortgage, or paying it off ahead of schedule.