Reply To: Paying your mortgage off early

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Dan Schointuch

@rusina, the numbers are going to be different for everyone, but there’s a calculator you can use here that will show you whether you’ll have more money pre-paying your mortgage or investing the difference:

For example, I said I had an extra $500 per month that I could either put towards my mortgage or invest in a retirement account, was paying $1,072 per month for principle and interest on the mortgage at 4%, and have $225,000 left to pay off (essentially, a new 30 year loan for a $280,000 home with 20% down). Using the $500 to pre-pay the mortgage would have it paid off in 16.2 years, so that’s the point at which we’ll compare net worth between pre-paying and investing the $500 instead.

When selecting an 8% investment return, matching the average long-term return of an aggressive investment in stocks (something like a 90/10 split between stocks and bonds in a portfolio), not pre-paying my mortgage and investing the $500 a month would leave me with a net worth $79,386 higher after 16 years than if I’d used the extra $500 to pay off my mortgage faster.

Now, let’s say my investments only earn an average of 5%, closer to long-term moderate bond yields. I’d still have $27,834 more by investing the $500 a month instead of using it to pre-pay the mortgage.

Or what if we get lucky and have a long-term bull market averaging 10%? By investing the $500 instead of pre-paying the mortgage, I’d have an extra $124,992 in net worth.

In fact, I’d actually have to earn less than 3% on my investments before pre-paying the mortgage starts to work out in my favor.

Now, what if I used a taxable brokerage account for the $500 a month investment instead of a tax advantaged retirement account? Earning 8% interest and after 16 years, I’d have $35,648 more in that account than my remaining balance on the mortgage. So at that point, I could simply sell enough of my investments to completely pay off the mortgage, leaving me owning my home free and clear after 16 years, and I’d still have $35,648 left in my bank account that I would not have had if I’d been using the $500 to pre-pay.

There’s also the fact that by putting any extra money into a single investment, the home, you’re not diversifying and exposing yourself to incredible risk that something goes wrong. Maybe sink-holes are found in your neighborhood, maybe the house next door is foreclosed on and starts a chain reaction driving down the value of every other home in your neighborhood, maybe the style of your home ends up looking really dated 30 years from now and isn’t worth what you thought it’d be worth. Any number of things could sink the value of that single investment.

By putting money into a properly diversified portfolio, you’re protecting yourself against something like that, the sudden decrease in value of any one investment due to circumstances outside your control.

Note: No employer match was used in these calculations, they do account for the deductibility of mortgage interest, and they assume a constant tax bracket.