Is Paying Off Your Mortgage Early Costing You Money?
A frequent question that pops into people's minds is whether they are throwing money away by paying off their mortgage instead of investing that sum. In reality, that's the last thing you should think about. Here's why:
The 1.5% Difference
Sure, the return of the stock market is higher than the interests one pays on mortgages, but is your money really earning the return of the market?
Instead of just focusing on what your money could do if you invest that sum in the S&P 500 index, you should really be thinking about the returns of all your assets as a whole because that's the true yield you are getting. This includes the equity in your home, all your savings accounts that are barely earning any interests, the bonds you own, and finally, the stocks that you have in your portfolios. (See also: 5 Creative Ways to Invest During a Weak Market)
But even if you forget about all that and just think of your investment portfolio, the results could surprise you. Say you get a 6% return, with taxes factored in, it would really be more like a 5% gain assuming you will have some long and short term gains as well as taxes on dividends.
On the other hand, your 4.5% 30-year fixed rate mortgage is more like a 3.5% loan with taxes. Hurray you say, because you are still making 1.5% more when you invest the money.
But hold on a second. A 1.5% difference on even $10,000, an amount you could likely come up with to either invest or pay off your mortgage, is just $150 a year. A whole year! I can save that much more just by cooking at home three more times, or by buying less coffee outside.
Think of These Factors Instead
Now, $150 every year for 30 years is very good money, but as we all know, a 6% return isn't a guarantee for everybody. Add the stress that people put onto themselves when they are leveraging, and $150 seems like a ridiculously small amount to be paying for the additional stress.
Instead of the additional money you are getting, think of the other advantages of not paying off your mortgage:
Liquidity — Your investments are more liquid than money tied up in home equity. Depending on how stable your income is, not paying off your mortgage could actually be the more conservative choice.
Asset Allocation — Are your real estate assets at a level that you would like? Remember to factor in just the equity that you've built, as any mortgages or loans that you owe is debt that needs to be repaid. Once you have the answer to this question, then you can easily figure out whether you should pay off your mortgages.
Freedom — This is a very personal question. My wife feels very strongly that we should pay off our mortgages early because she feels much more secure when she is debt free, even if she has the same amount of money in the stock market. I lean towards that side as well, though not nearly as extreme.
For us, being debt free will probably lead us to live a healthier, happier life. But it might not be the same for you, as some people will feel more secure when they have a large balance in their portfolio.
So really, there is no right answer. Do what make sense for your situation and what feels comfortable to you and don't worry too much about wasting money either way.