Pay Off Your Mortgage or Invest the Money?
As you invest your money, shop for a home or tackle any one of the many financial decisions you have to make over your lifetime, do you sometimes wish you’d paid more attention in math class? Do you find yourself having to "run the numbers" and wondering what’s best?
The solution isn’t always black and white, and the "right" answer may depend on things you can never know for sure, like your tax bracket in 2020 or how much your investments will grow.
When it comes to paying off your mortgage early or investing the extra money, the "feel-good choice" is not necessarily the smartest choice.
Paying off your mortgage (or any loan for that matter) is an investment, and your return is essentially the interest rate on the loan. If you have 25 years left on a 30-year mortgage with a fixed rate of 6.2 percent and you deduct your interest payments on your taxes, you’ll earn 4.5 percent by prepaying the loan (assuming you’re in the 28 percent tax bracket).
Now let’s say you invest your spare cash in stocks instead. You’ll pay a 15 percent tax rate on your long-term capital gains and dividends. (At least that’s the current rule… what the future rate(s) will be is anyone’s guess)… So to beat the 4.5 percent return you’d get from prepaying your mortgage, you’d have to earn just 5.3 percent a year on your stocks before taxes.
The odds of your doing that over the 25-year remaining term of your mortgage are excellent: Historically, a portfolio of 80 percent stocks and 20 percent bonds has returned 7.5 percent a year after taxes.
Remember, though, that by prepaying your mortgage, you are reducing your liquid assets. If you suddenly need money for something, it’s easier to sell a mutual fund than it is to pull cash from your home, and you can always pay off your mortgage later with the money you invest now.
The bottom line – Investing wins.
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