Where should you put your extra cash each month? Two common options are to invest more or to pay extra to the mortgage. Both options have many different factors to consider in this decision. A helpful way to ponder these factors is to break them up into two categories: emotional and measurable.
Emotional Factors
· Debt Burden: How much does having a mortgage affect you? It is common for people to feel anxiety about having a larger debt obligation. Is it minor feeling or is it frequent pressure to have the debt paid off? If it is a minor feeling, you may be better to consider putting more into investments. If the debt is a constant weight on your shoulders, it may be to consider paying extra on the mortgage.
· Tolerance for Risk: How do you react when the value of your investments decreases in the short term? The primary paradox of investing is the more risk you are willing to take; there should be a higher opportunity for reward. This does not always work out perfectly, but it is common for riskier assets to have more ups and downs in short term while having a higher rate of return in the long term. If you are person who sells all your stocks when the market is down, it may be better to just pay off the mortgage and take the more guaranteed win of paying less in interest. If you are one to hold or buy more when your stocks are down, then it may be better to put more investments since you are comfortable with the risk vs reward tradeoff.
Measurable Factors
· Interest vs Rate of Return: How high is the interest on the mortgage and how high is the expected rate of return on the investment of your choosing? Investing in the US stock market typically averages between 6-12% annually over a 10-year period. This does not mean it gets that rate every year, the stock market may be up as much as 40% in one year and down 30% the next but tend to be up more than it is down. You could also prefer a more conservative investment that averages between 2-5%. If your mortgage interest rate is higher than the expected rate of return, then paying extra on the mortgage could be better.
· Tax Benefits: Does the mortgage interest consistently reduce your tax burden since you itemize your deductions on tax returns? How much? This factor isn’t always the easiest to calculate, but if the tax savings are minimal, then paying extra to the mortgage is possibly more beneficial. If the opposite is true, then putting extra into investments is possibly more beneficial.
A common mistake made with finances is not understanding how emotions and numerical factors both play a part in monetary goals. You should take both into account when you draw a conclusion on this decision.
This is an example of a few factors to consider, but your situation may be more complicated. Needing extra assistance, please reach out and we can cover your options in more detail.
The content is developed from sources believed to provide accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation.
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