There are some people who swear by paying their mortgages off early, but others say it is more beneficial to invest any money you would spend on prepayment elsewhere. Learning more about the various pros and cons associated with prepaying your mortgage can help you make better decisions about your own financial future.
How Much Could You Really Save?
When you make your mortgage payment each month, that money goes to two different things. Part of it goes toward your actual principal balance – or the amount of your outstanding debt – and part of it goes toward the interest, or the amount you pay the lender. When you make extra payments on the principal debt, you reduce the amount of interest you will pay over the life of your loan.
Just as an example, if you have a $100,000 30-year mortgage with a 6% fixed interest rate, paying an additional $100 every single month would reduce the length of time it would take to pay your mortgage off from 30 years down to 21, and it would save you roughly $40,000, too. For most homeowners, simply hearing those figures is enough to convince them to start putting more money into their mortgages.
Are Other Investments Better?
Saving $40,000 in interest and paying off your mortgage nine years early might sound heavenly, but what if you could do even more with the very same $100 a month? Some experts believe using that $100 to strategically buy stocks and bonds will be more profitable for you in the end. Think of it like this: every $100 you make in extra payments each year saves you $6 on interest. If you could instead earn a higher percentage – say 10% of that $100 – by investing it elsewhere, you would earn even more money over the same timeframe, which more than makes up for the $40,000 the lender will receive over the course of 30 years’ worth of mortgage payments.
Which Option is Right for You?
Before buying your home and signing a mortgage contract, it’s important to make sure that you’ve gotten the best possible deal based on your credit history and the home you’ve chosen. Once you have accomplished this, think about the benefits associated with paying either the mortgage or investing your funds:
- Prepaying Your Mortgage: When you put an extra $100 a month on your mortgage, you can rest comfortably in the knowledge that you will get a fixed return on that money. Every $100 you pay will result in $6 in savings in terms of interest.
- Investing the $100: On the other hand, while it may be possible to earn more by investing the $100 in stocks or mutual funds that pay a higher percentage than your mortgage’s interest rate, it’s important to remember that these are not sure things. Stocks that pay you such a percentage are often somewhat unpredictable, which means that you may not get the return you expect.
In a nutshell, if you are someone who prefers to know beyond a shadow of a doubt exactly what you will get in exchange for your $100-a-month investment, you may want to consider prepaying your mortgage. On the other hand, if you are confident in your abilities, or if you trust your financial analyst to help you invest that same $100 appropriately, then investing could substantially increase your earnings.