Should you prepay your mortgage or invest? (We have the answer)
Have extra cash? Should you invest or prepay your mortgage?
In the last quarter of 2019, the U.S. Financial Health Pulse 2019 Trends Report estimated that, even in this strong economy, only 29% of Americans polled reported they are financially healthy and on track for long-term stability. Over one-half (54%) of Americans polled admit to struggling with some aspects of their fiscal plans, and an unfortunate 17% fail to make ends meet on a monthly basis.
The Investment argument:
Let’s compare two homeowners. Ms. A has a $300K, 15-year loan at 3.25% interest rate. and Mr. B also has a $300K loan at 3.25% interest rate, but his is a 30-year loan. Ms. A has a monthly payment of $2,108.00 and, due to her high monthly payment, is not able to contribute anything extra towards investments nor mortgage prepayment. After 10 years, Ms. A has $136,847.22 left on her mortgage, and $163,152.78 in equity. Mr. B has a monthly payment of $1,320.00 and has a little extra cash every month. He has opted to invest an amount equal to half of his mortgage payment into the stock market on a monthly basis. Current stocks average 8% interest per year, and after 10 years, Mr. B has a $126,482.49 stock portfolio along with $71,847.53 in home equity. In total equity, he has $198,330.02. The numbers get even more impressive the longer the term.
It’s important to note here, that if and when interest rates rise (remember the 1980s and the interest rates which hovered around the 8-10% mark?), it would be a good idea to prepay your mortgage with any extra cash instead of investing, as it would be hard to top that in the stock market.
The bottom line: Should you prepay your mortgage or invest?
Plugging extra cash into a mortgage is beneficial only if 1) you can’t beat the return rate with the stock market, and/or 2) you don’t end up needing that extra cash when an emergency arises. Sure, you can refinance for cash out or get an equity line, but banks will only loan your money back to you if you have a job. What happens if said emergency happens to be sudden job loss or an accident that prevents you from going to work? Before you make any optional financial commitments, be sure you’ve got a solid 3 -6 months of cash reserves in case of a job interruption.