You’ve been working hard for decades and sticking to a budget to set yourself up for a successful financial future. But now something strange is happening: You have more money on a monthly basis than you actually need. It’s a good problem to have, but now you need to figure out what to do with the excess.
If you just let the money build up in your checking account, it’s not working for you. Most people end up doing one of two things: invest the money or pay down their mortgage. Which one is better for you?
What The Numbers Say
First, let’s take a look at some math and see what the numbers say. The biggest factors are your mortgage rate and expected investment return. With those in mind, you can do some rough calculations to find a break-even point where one decision would be worth more financially than the other.
For example, if you have a mortgage with a rate of 5%, you would not earn enough on an investment returning 4% to make the investment worthwhile. That would be like borrowing money at 5% to earn 4%, or essentially giving away 1%. If you could earn 10% on your investment, then it would make sense, because you would earn twice what it was costing you.
A thorough analysis would also need to factor in things like taxes on investments, mortgage interest deductions, risk, and PMI. An experienced financial advisor can run all of the calculations and conduct a complete analysis of your unique situation.
Pros And Cons Of Paying Down Your Mortgage
There are some pros and cons of paying down your mortgage that go beyond the raw math. One downside is the lack of liquidity once you put the money towards your mortgage. Once it’s in there, for all intents and purposes, it’s gone. The only way to get the money back out is to sell your house or refinance your mortgage. If you invest the money, you have quicker access to it in case of an emergency or a change of mind.
One of the advantages 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 earlier in your retirement years. This will free up more of your money before your medical expenses start to add up.
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 carry some risk of having a lien placed against your property.
How Does PMI Factor In?
Maybe you shouldn’t just choose one or the other. Perhaps the best answer for your situation is a combination of the two. If you have less than 20% equity in your property, you are most likely paying private mortgage insurance, or PMI. For PMI, you have to pay additional premiums on top of your standard mortgage principal and interest payments.
Even if you can earn 6% on an investment and your mortgage rate is only 5%, you may still earn a higher return on your money by paying down your loan. When you pay it down to 80%, you free yourself of PMI. It may be best for you to pay your mortgage down, and then start investing once your PMI is gone.
How I Can Help
This is a general idea of how the decision process works, but as I mentioned above, there are a lot of other factors to consider. At HBA Wealth, our goal is to make it easier than ever to accomplish your goals and achieve financial freedom. We can help you calculate the best return on your money in your specific situation and evaluate all your options. Contact me at (626) 529-8347 or email me directly at [email protected] so we can work together to ensure your money is working efficiently for you.
Ricky Biel, CRPC® is a wealth manager with Haydel, Biel & Associates, an independent financial advisory firm serving individuals and families near Pasadena, California. The firm was founded in 2004 by Chris Haydel and Ricky Biel with a desire to provide unbiased, client-centered, community-based financial advice. Together, they have built a practice that has grown into a family of caring, smart professionals committed to blending proven investment methodologies with creative financial technologies that make it easier than ever to accomplish your goals. They strive to keep things simple and fun to give their clients peace of mind and alleviate financial stress. HBA Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the HBA Wealth team may be able to help, contact them today at (626) 529-8347 or email Ricky directly at [email protected].