You are in the fortunate position where you have more money each month than you actually need. The question is, what should you be doing with those extra funds?
There are several options, of course. You can spend it, save it, invest it, or use it to pay off debt. For most people, it comes down to two options: either paying extra on their mortgage or investing the funds. Which is the best choice for you?
Let’s take a look at the pros and cons of each.
What Makes the Most Financial Sense?
When deciding between these two options, you first want to know which option can provide the greatest payoff. In this case, it’s your mortgage rate versus your expected investment return. You can calculate some rough estimates to evaluate which decision would make more financial sense.
Let’s consider an example. Say your mortgage interest rate is 5%. If you estimate that, based on your risk tolerance and time horizon, you can expect 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 are an aggressive investor and believe you could earn 8% on your investment, it would make more sense to invest.
This may sound simple on paper, but there are a lot of factors at play. And as we all know, even the best of predictions aren’t set in stone. It’s important to run a thorough analysis and factor in taxes on investments, mortgage interest deductions, risk, and private mortgage insurance, among other elements of your financial life. An experienced wealth advisor can run all of the calculations and do a complete analysis of your unique situation.
Pros and Cons
There are some pros and cons to each that go beyond the raw math. Liquidity is one big pro for investing. You’ll have easier access to it in case of an emergency. However, if you put the money towards your mortgage, it’s gone, for all intents and purposes. The only way to get the money back out is to sell your house or refinance your mortgage.
However, an advantage of 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 sooner during retirement. That way you can 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.
Another benefit of paying off your mortgage completely is decreasing your risk. Once you own your home free and clear, you never have to worry about a foreclosure or having your credit damaged by missed mortgage payments. However, you still have to pay your taxes and carry some risk of having a lien placed against your property.
A Combination of the Two
For some people, it may make more sense to choose a combination of these two options. For example, if you have less than 20% equity in your property, you may be required to pay private mortgage insurance, meaning you owe additional premiums on top of your mortgage principal and interest payments.
In this case, even if your mortgage rate is 5% and you can earn 6% on an investment, you may still earn a higher return on your money by paying down your mortgage. Once you pay it down to at least 80%, then you free yourself of needing private mortgage insurance and then you can start investing, should you determine that that’s a more appropriate option for you.
How We Can Help
Do you need guidance on the best way to optimize your extra funds? We at Favor Wealth are here to put you first and help you live the life you want; reach out today to start the conversation. Contact us at 626-529-0445 or email Ricky directly at email@example.com.
Ricky Biel is founder, wealth manager and Chartered Retirement Planning Counselor℠ professional at Favor Wealth, an independent financial advisory firm serving individuals and families near Pasadena, California. Ricky Biel founded Favor Wealth with a desire to provide unbiased, client-centered, community-based financial advice. Ricky and his team of caring, smart professionals want their clients to feel like they’ve done them a favor, making it easier than ever to accomplish their financial goals by blending proven investment methodologies with creative financial technologies. He is on a mission to help his family of clients feel both a sense of relief and excitement about their future. Favor Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the Favor Wealth team may be able to help, contact them today at 626-529-0445 or email Ricky directly at firstname.lastname@example.org.
The commentary on this blog/website reflects the personal opinions, viewpoints and analyses of the Favor Wealth Advisors’ employees providing such comments, and should not be regarded as a description of advisory services provided by Favor Wealth Advisors or performance returns of any Favor Wealth Advisors’ Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Favor Wealth Advisors manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.