By Matthew Gaude & Shawn McGuire
How many times have you heard that mortgage debt is good debt? We know that debt reduction is a healthy financial goal, especially when it comes to high-interest debt such as credit cards or student loans. And we also know that it’s important to minimize debt so that when we retire, we aren’t using our nest egg to pay off loans. But do these principles apply to your mortgage? Should you throw every extra dollar toward your mortgage or should you invest that money instead? Like most financial choices, the answer is going to differ depending on your unique situation. Let’s look at the pros and cons of each strategy.
The Growth Factor
The most important factor when evaluating your options is that of growth. You don’t want to leave your additional funds sitting in a savings or checking account where you’re earning less than a percent of interest. You want your money to work for you, so the question to ask is, “What option will give you the biggest payoff?” In this case, you’ll find the answer by pitting your mortgage interest rate against your expected investment return. You can calculate some rough numbers to assess which decision would make more financial sense.
Let’s take a look at an example to give you some context. Say your mortgage interest rate is 5%. If you estimate that, based on your risk tolerance and time horizon, you can pursue an investment return of 4%, it would make more sense to pay down your mortgage. Otherwise, you’re potentially throwing away 1%. However, if you aren’t as conservative with your investments and believe you could earn 8% on your investment, it might be more beneficial to invest.
This may sound simple on paper, but there are plenty of factors that could affect the outcome. And as we all know, even the best estimates aren’t guaranteed. It’s important to run a thorough analysis and consider taxes on investments, mortgage interest deductions, risk, and private mortgage insurance, among the other elements of your financial life. An experienced financial advisor can run all of the numbers and conduct a complete examination of your unique situation.
Financial Flexibility
There are some pros and cons to each choice that go beyond the raw math. Liquidity is a significant pro for investing since you’ll have greater access to the funds in case of an emergency. If you put the money toward your mortgage, for all intents and purposes, it’s gone. The only way to get the money back is to sell your house or refinance your mortgage.
On the other hand, an advantage to 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 retirement. This lets you free up more of your money before your medical expenses start to build. If you invest, your mortgage will be another bill you have to pay while in retirement.
The Diversification Question
When it comes to minimizing risk, we have all heard of the importance of diversifying our investments. In this case, if you are heavily invested in real estate, paying off your mortgage will add even more eggs to the same basket. If the housing market crashes, so will a significant chunk of your portfolio. From a risk standpoint, you may be better off holding onto the mortgage and keeping your portfolio more diversified.
Is Being Debt-Free Important To You?
Let’s say that you have a relatively low interest rate and aren’t worried about paying another bill in retirement. Does that mean you should hold on to your mortgage? Not necessarily, because there’s a factor that cannot be calculated or plugged into a formula: peace of mind. Some people don’t want to have any debt to their name, and eliminating it would relieve them of a financial burden. Others have no problem carrying debt if it makes financial sense and they are being wise with their money. When deciding whether you should pay off your mortgage, don’t forget to factor in your values and how you feel about debt.
It’s Not All Or Nothing
For some people, it may make more sense to choose a combination of these two choices. Maybe that looks like adding more money to each mortgage payment to bring down the principal while still putting the bulk of your extra money in other investments.
Why Are You Not Refinancing Your Mortgage?
If you are not able or if it does not make sense to pay off your mortgage, then you need to be looking at refinancing your existing mortgage or possibly other debt you may have. Mortgage rates are at all-time lows currently. For instance, current mortgage rates are as follows:
- 30 year fixed at 2.5%
- 20 year fixed at 2.5%
- 15 year fixed at 2.125%
- 10 year fixed at 2.25%
With mortgage rates as low as they are and depending on your existing interest rate, you may be able to save interest payments and maintain your same mortgage payment by shortening the term of your mortgage. Depending on how long you have lived in your house, you may be able to shorten the term of your mortgage from 30 years to 20 years or possibly even shorter, which will save you a lot of interest and principal payments.
Let’s look at an example of how you can save money refinancing:
Math of refinancing
Let’s say you have 25 years left on a 30-year mortgage that started out at $300,000 at 3.75%.
Your monthly payment = $1,389
Total debt remaining after 5-years = $270,232
Remaining interest to be paid = $146,567
What are the numbers If you refinanced into a new 20-year at 2.50%?
New payment = $1,212 ($177 less a month)
Total interest paid = $93,461 ($53,106 less than the current mortgage)
Total savings by refinancing = $95,586
What if you invested the $177 monthly, earning 6% over 20 years?
This would yield an additional benefit of $80,826
Total benefit by refinancing = $176,412*
We have a strategic relationship with a mortgage broker who can discuss your current mortgage rate and balance and run some scenarios to determine what makes the most sense for your specific situation. Contact us and we will provide you his information.
As you can see, there are several variables to consider. Paying off your mortgage is a big financial decision, and before making such important decisions, it’s always a good idea to consult with a financial advisor. At Live Oak Wealth Management, our advisors can give you personalized financial planning advice, and we might even be able to show you alternative investment strategies you hadn’t considered. You can reach us by calling our office at 770-552-5968 or emailing [email protected]. Or, if you prefer, you can simply click here to schedule an appointment online.
*These numbers do not take into account the cost to refinance which will vary from zero (if you can get the same lender to adjust the rate) to several thousand if a new appraisal and other typical closing costs are incurred.
About Matthew
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insight and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
About Shawn
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc. (APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk, and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors. Seek tax advice from a tax professional.