Save on your mortgage, invest your money, or do both
Perhaps you have additional cash flow thanks to an increase, or you recently received a large amount of money.
What's the best way to use those dollars for you?
Should you pay your mortgage extra to shorten your loan term and save interest? Or should you invest on the stock exchange?
Maybe you should do both – refinance to save your loan and invest the rest to get higher returns.
The correct answer depends on your risk tolerance and your long-term goals.
Check your eligibility at today's interest rates (July 28, 2020).
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Let's look at an example to show how much you can benefit from paying off your mortgage early rather than investing these additional funds.
Suppose you recently received a raise. You now have an additional $ 2,000 a month.
What happens if you use this extra money for early mortgage payments?
Repay your mortgage early
"Suppose you bought a house for $ 250,000," said Katsiaryna Bardos, associate professor of finance at Fairfield University.
You borrow $ 200,000 on a 30-year mortgage loan. Your fixed interest rate is 3.25%. Your mortgage loan payment is $ 870 per monthIn those 30 years, you would pay $ 113,350 in interest
"However, if you made additional payments of $ 2,000 each month," explains Bardos, "you would pay off your mortgage in 6.5 years and only pay $ 21,900 in interest during that period."
Your total interest savings would be $ 91,400
That is a huge amount of money back in your pocket.
However, this example assumes that you stay in the house every 30 years and repay your loan in full – which most homeowners don't.
So let's see how yields can be compared if you invest the $ 2,000 a month instead of paying your mortgage extra.
Invest in the stock market
History shows that other investments can deliver a better return than the interest rate you are likely to pay on your mortgage.
"The historical return on the stock exchange is around 8%," says Bardos. She gives this example:
You invest $ 2,000 a month for 6.5 years. Suppose you earn 8% annual returnIn this case, you will earn $ 203,700 – about $ 112,300 more than the $ 91,400 you would save by prepaying your mortgage
Remember that mortgage interest rates are currently well below the average returns on the stock exchange.
This means that you make more money by investing than by early repayment of mortgage interest.
"From a purely financial perspective, it can generally make more sense to provide additional money for your investments than to repay your mortgage early," says Anna Barker, personal finance expert and founder of LogicalDollar.
Mortgage rates are currently lower than average returns on the stock market. So you can often earn more by investing than saving by paying the mortgage interest early.
However, the return on your investment is not guaranteed. You could lose money if you invest in stocks or bonds.
"If you have a fixed rate mortgage, investing in your home is a safe bet – you know exactly how much money you will save on interest," said Elizabeth Whitman, lawyer / executive member of Whitman Legal Solutions, LLC.
So if you choose to use your hard-earned money, you also need to consider your personal risk tolerance.
If you are unsure whether to make the decision yourself, speak to a financial advisor to find out what makes the most sense for you.
If you have a flat rate in cash, should you repay or invest your mortgage early?
Here's another scenario: an elderly relative dies and you inherit $ 100,000 after tax.
They discuss whether it is wiser to target the entire lump sum to your mortgage or to invest it in stocks or your pension funds.
Suppose you pay off your mortgage by $ 100,000 in the first month that you borrowed a total of $ 200,000.
In this example, you pay a total of $ 20,300 interest for a Total savings of $ 93,000
"Your mortgage would be repaid in 11.5 instead of 30 years," explains Bardos.
Alternatively, you can invest the $ 100,000 in stocks that will return 8% over 11.5 yearsWith these metrics, you would earn $ 243,900
Whitman warns that putting all that money into your home isn't a good idea, especially if it's your only investment.
“You should have different types of assets, such as: B. stocks, bonds and real estate so your portfolio is diversified, ”says Whitman.
It's not necessarily a good idea to put all that money into your home – especially if this is your only investment. You should aim for a more diversified portfolio.
"If the stock market falls, there is a chance that you won't lose as much money if, for example, the real estate and bond markets remain stable."
Assuming that your return is cheap, investing some or all of the $ 100,000 in pension funds may be your best bet.
“With an IRA, 401 (k) or similar investment, you can invest the money with dollars before taxes. You also don't pay taxes on the money until you withdraw it, ”Whitman suggests.
How to pay off your mortgage early
If you want to repay all or part of your mortgage early, there are several options.
Saving additional dollars to your mortgage in the form of accelerated payments can save you money.
This tactic can reduce the amount of interest accrued over the course of your loan of thousands of dollars. It can also shorten the term of your loan by several years.
For accelerated payments, send additional money to your lender or credit service provider every year or more. You must indicate that these additional dollars must be applied to your capital. This strategy reduces the interest that will accrue on your mortgage in the future and shortens the term of your loan, so that you can repay your loan more quickly
>> relatives: This is how you can pay off your mortgage early (but should you?)
“By either paying more than the minimum repayment amount per month or making payments more often, you can reduce loan capital faster,” says Barker.
"This, in turn, means that the total amount you owe will continue to be reduced more quickly than originally expected because less interest will be applied to the now reduced capital."
You can make accelerated payments by either:
Pay a little more every month Make payments every two weeks (26 smaller payments per year instead of 12) or make an additional payment per year (13 total payments instead of 12)
However, prepaying your mortgage through one of these options may not be the best step. Many homeowners are likely to get a higher return on their money if they invest it.
The right choice for you depends on how much risk you want to take.
“Repaying your mortgage is essentially a risk-free investment. You know how much you will save in advance, ”says Bardos.
“Most other investments with higher returns are associated with higher risks. You can and can lose money. So take your overall portfolio, your risk appetite and your time horizon into account when making investment decisions. "
Also consider some other things before pursuing either option:
Does your mortgage allow easy repayment? Or is there a penalty for prepaying your loan? "This can affect you both ways if you incur costs that may not make early repayment worthwhile," says BarkerWhat are your financial goals? “Investing the money can make more sense from a financial perspective. If you don't feel comfortable with the amount of your debt, it can help you sleep better at night if you include part of it in your mortgage, ”Barker emphasizesDo you like to invest so much at once? “Depending on market developments, your risk appetite and your overall investment strategy, it may not work if you invest additional money at once. In this case, you may prefer to use part of the money for your investments and the rest for your mortgage, ”advises Barker
Alternative option: refinance your mortgage to save
You may not have to choose between saving your mortgage and investing in the stock market.
There is a third option to consider: refinance to save money on your home loan and invest the rest of your money in higher yielding assets.
You may be able to achieve both goals – early repayment of your mortgage and return on investment – if you refinance in a shorter loan term.
However, shorter mortgage terms mean larger payments. If you do that, you may not have much money left.
You can also refinance yourself on a new 30-year mortgage with a lower interest rate.
With today's almost record-low mortgage rates, you could still save a significant amount of your total mortgage rates and have money to invest.
Know what your financial goals are, explore your options, and make sure you choose the best strategy to get you there.
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