A few days ago, I started the discussion on whether you should use extra money to invest or focus on paying down your mortgage. The argument thus far for investing extra money has been that investing is smarter because you will earn more in investment returns than what you’re spending in mortgage interest. To take this argument deeper, I want to be fair to those who sit on that side of the fence. Their claim is valid, but let’s talk about why I still disagree.
The crux of the financial advisor’s position when he encourages you to invest in lieu of paying off a mortgage is that you can outpace your interest costs on a mortgage with good investment returns. If he can’t convince you, he may suggest you put money you planned to use to pay down your mortgage into investments, let it grow to a balance greater than that of your mortgage, then use those funds to pay off your mortgage. He says doing it this way gives you the best of both worlds – I say he’s wrong. Here’s why.
When you convert dollars owed vs. dollars invested the math isn’t always easy. For instance, if you owe $100,000 on your mortgage and at 6% interest, you’re paying roughly $500 per month in interest (1/2% of $100k). You’re invested amount would have to make more than that in interest for it to win out. While it may do so as a percentage, think of it in dollar amounts. Unless you had $100k invested somewhere earning at least that much interest (or $50k earning twice that, or $25k earning four times that, etc.), you won’t win out using this approach. You also would have to pay taxes on your investment gain, diluting the earnings by as much as 30% or more. Pause for a minute to “take a breath before we dive deeper.”
Reality is that there is a point at which your investment’s interest earnings will outpace your mortgage interest savings as the investment grows and the debt shrinks, but where that falls is dependent on your mortgage amount and interest rate (two knowns) vs. the BIG UNKNOWN of what you would earn in interest on your investments (both as a percentage and dollar amount).
There are no guarantees with general investments like stocks, bonds and mutual funds. Statistics show you will make money in the long run, but you have no way to calculate how much you will make (or lose) over any given length of time. Investing has its risks and you’re taking them with every penny you invest.
Let’s boil it all down. I would never invest money with the purpose of later using it to pay off a specific debt. I would ALWAYS pay off that debt and invest whenever the debt is paid off. Taking my advice will pretty much guarantee you pay off your mortgage (at the risk of losing some investment earnings). Taking the financial advisor’s advice means you won’t pay off your mortgage earlier unless your investments do really well. Which risk do you want to take?