Should You Pay Off Your Mortgage Early or Invest? | Financial Advisor Explains

Summary

This video explores the financial decision of whether to pay off a mortgage early or invest the extra money. It emphasizes the importance of understanding mortgage amortization and the impact of interest rates on the principal balance. The script compares mortgage interest rates to historical stock market returns, suggesting that investing is generally more beneficial unless the mortgage rate is significantly higher. It also discusses strategies for accelerating mortgage payoff and the non-financial benefits of being mortgage-free, such as peace of mind and financial freedom.

Takeaways

• 🏠 Paying off your mortgage early or investing depends on your mortgage interest rate and personal financial situation.
• 📈 Mortgage payments consist of principal repayment and interest, with interest payments being frontloaded in an amortization schedule.
• 💡 Understanding the amortization schedule is crucial to making informed decisions about mortgage payments and investment strategies.
• 🔢 In the first 20 years of a 30-year mortgage, interest payments often exceed principal payments, leaving a significant balance still owed.
• 💰 The total interest paid over a mortgage can be substantial, sometimes equal to or more than the original loan amount.
• 📊 Historically, the stock market has offered an average annualized return higher than typical mortgage interest rates, suggesting investing might be more lucrative.
• 🤔 The decision to pay off a mortgage early or invest is influenced by factors such as interest rates, time horizon, and personal financial goals.
• 📉 However, investing comes with risks, as not all years return positively, unlike the guaranteed return from paying down mortgage principal.
• 🏦 Strategies to pay off a mortgage early include making bi-weekly payments, adding extra payments, or applying windfalls to the principal balance.
• 🚀 Making extra payments can significantly reduce the time and interest paid on a mortgage, providing financial and psychological benefits.
• 💼 Paying off a mortgage early can lead to peace of mind, freeing up funds for other uses, and improving financial stability for the future.

Q & A

What is the main factor to consider when deciding whether to pay off a mortgage early or invest?

The main factor to consider is the mortgage interest rate. A higher interest rate on the mortgage may make it more financially beneficial to pay off the mortgage early rather than investing the extra money.

How is a mortgage payment typically broken down?

A mortgage payment is typically broken down into two components: the principal, which is the borrowed amount that needs to be paid back over time, and the interest, which is the cost of borrowing money that is applied to the remaining balance.

What is an amortization schedule and why is it important?

An amortization schedule is a table that details each monthly payment on a loan, showing how much of the payment goes towards the principal and how much goes towards the interest. It's important because it helps understand how the mortgage is paid off over time and the distribution between principal and interest payments.

Why might the majority of a mortgage payment in the early years go towards interest rather than the principal?

Banks frontload the interest payments because they need to get paid first. This means that in the early years of a mortgage, a larger portion of each payment is allocated to interest, and less to reducing the principal balance.

What is the average annualized return of the S&P 500 since 1957?

The S&P 500 has an average annualized return of around 10.26% since 1957. However, after considering taxes, a more realistic expectation for investors might be a return of around 7 to 8%.

How does the interest rate on a mortgage compare to historical stock market returns when deciding to invest or pay off the mortgage early?

If the mortgage interest rate is lower than the expected return from the stock market, it might be more financially advantageous to invest rather than pay off the mortgage early. Conversely, if the mortgage interest rate is higher, paying off the mortgage early could save more money in the long run.

What are some strategies to help pay off a mortgage early?

Some strategies include making bi-weekly payments, which effectively makes one extra payment per year; paying an extra fixed amount each month; and applying any windfall cash, such as tax refunds or bonuses, towards the principal balance.

How can making bi-weekly mortgage payments affect the total time and cost of a mortgage?

Making bi-weekly payments can significantly reduce the total time of a mortgage and the amount of interest paid. For example, on a $400,000 mortgage at a 7% interest rate, bi-weekly payments could save over $134,000 in interest and shorten the mortgage term by 6 years and 1 month.

What are some intangible benefits of paying off a mortgage early?

Intangible benefits include peace of mind from not having a mortgage payment, freeing up money for other activities or investments, lowering the debt-to-income ratio which could improve credit score, and having the home ready for retirement or as an asset to pass down.

Why might someone choose to pay off their mortgage early even if the financial benefit is not the highest?

Some people might choose to pay off their mortgage early for non-financial reasons, such as the peace of mind that comes with being debt-free, or the desire to have the home fully owned for retirement or to pass on to heirs.