This guide will help you assess your current financial situation, the pros, and cons of both options, and ensure you make an informed decision.
If one day you find yourself having some extra cash, a growing interest in the stock market, and making monthly mortgage payments, you will probably be at a loss as to how to spend your money wisely. It is important to remember that you are not the first one to face this dilemma.
Financial experts have been continuously debating about the best strategy to use in this case. Although the benefits of getting out of the mortgage burden may be evident, investing seems far more profitable in the long term.
Unfortunately, there is no universal strategy to go about it. You have to consider your risk tolerance and long-term life goals, as well as the current economic situation. Here is what you should know about each option before making your choice.
Mortgage Payoff
Let’s look at an example and see what the math says. Here are the details:
- You have a 30-year mortgage of $300,000.
- You have a fixed interest rate of 3%.
- Your monthly payment is $1,264 before taxes and fees.
Various Mortgage payment calculators show that by paying an extra $500 monthly, you will pay off your mortgage in 18 years and six months and save $63,736 in interest.
What are the benefits?
- Psychological comfort: Although this is not exactly about money, your peace of mind is one of the major factors to consider. Owning your own home with no more monthly payments gives you a sense of security and lowers the stress level in our hectic times.
- Freeing up the cash: Without mortgage payments, you can start saving up for some more pleasant things like family holidays or expensive gifts for your beloved ones. You will also be able to shift the money to deal with other debts.
- Building equity: This is closely related to the previous point. Creating a cash cushion or simply having some extra cash for unforeseen expenses is a top priority in maintaining financial security. Paying off your mortgage makes it easier to build your emergency fund.
What are the drawbacks?
- Missing out opportunities: Spending money on your mortgage means you won’t be able to invest them in some more lucrative offers. It may also result in cutting off your retirement savings or putting on hold your investment activity.
- Little cash: You should be very careful not to become overenthusiastic with your mortgage payoff. Keep some extra money in a savings account to ensure you always have access to some cash.
Stock market investment
As an alternative to paying off your mortgage, you might want to invest your hard-earned dollars in a fund tracking the S&P 500 Index.
- You invest $500 monthly for 18.5 years
- The average annual return from the S&P 500 is about 10%.
According to the Investment Calculator, you’ll have around $300,000 on your balance at the end of this period, $191,935 being your total interest income before taxes.
What are the benefits?
- Financial gain: Investing in the stock market is more beneficial financially. Average stock market returns are usually higher than mortgage rates, meaning you stand a high chance of getting more money (investment returns give you $128,199 more than payoff profit in our example).
- Tax sheltering: By investing in an RRSP, you can reduce your tax and gain an extra advantage from that.
What are the drawbacks?
- High risk: There is no guarantee that the stock market returns will be similar to the average ones. When investing in stocks or bonds, you should be ready to tolerate the volatility of the market and the risk of losing your money.
- Keeping the debt: Although the idea of investing your money more profitably may seem appealing, you should remember that until the mortgage is paid off, you don’t own your home. Investing may not be the best option if you want to get rid of the monthly payments and start debt-free living.
Making the right choice
As mentioned before, the chosen strategy will largely depend on your personality and financial aims. There is no correct way of dealing with extra money, but we hope that the information above will help you consider your options in more detail and come to a deliberate conclusion.