A couple of weeks ago, we suggested “3 Totally Doable Mortgage Hacks That Could Save You Thousands,” which delved into the money you can save on interest by spending a little bit more money towards your principal over the scope of your home loan. While we totally stand by those hacks (they’re financial-planner approved), a smart reader pointed out that if the interest rate on your mortgage is 5%, for example, and the current 30-year market growth rate for a portfolio of investments is around 8%, then you should instead invest the money instead of paying down the mortgage faster.
We thought this was a tip worth delving into, so let’s look at how this pans out using some very simple numbers: If you have a $300,000 30-year, fixed rate mortgage at 5% interest and you commit to paying an extra $100 every month, you’ll save nearly $40,000 in interest over the term of the home loan. However, if you instead put that $100 monthly into an investment that compounds annually with an 8% rate of return of 30 years, you’re likely end up with $140,855 when your mortgage ends. You will, however, have to spend the extra $39,937.25 on your mortgage, so your compared return will only be around $100,000—still, not a number worth ignoring. Again, this is a simplistic look at this concept, but it gives you a good idea on what the rate of return could be.
To get a second opinion on this, I reached out to Douglas Boneparth, financial advisor and president of Bone Fide Wealth, LLC, for his take on this advice. He says that it is always a smart idea to look at the spread (or the difference between the two interest rates) what you could get through investing and your mortgage rate. However, he thinks 8% is a little more aggressive than reality. Additionally, he thinks this rate of return usually doesn’t include tax considerations—which can both help your rate of return (since mortgage interest is tax-deductible, for now), and also hinder it in some situations (if you take advantage of pre-tax income contributions that are taxed later). Additionally, the investment timelines for portfolios with 6-8% return are usually long-term return rates. It is smart to do this, he says, if you have a mortgage with 10 or more years to go, when these longterm rates apply.
However, Boneparth cautions that these rates are not guaranteed. A few commenters echoed this statement as well, adding that yes, you could make more money investing the extra dollars you’d pay towards your principal, but the freedom and peace of mind that comes with paying off your mortgage early—and not having to make housing payments every month—is a priceless feeling.
Additionally, before you switch your mortgage payoff plan, Boneparth says that you should take your goal priorities into account: If you’d rather have cash on hand now, maybe putting that extra $100 each month into a savings account is a better plan for you than an option where you can’t touch it for three decades without penalties.
Have any other smart mortgage advice? Share in the comments.