By Vincent R. Birardi, CFP®, AIF®, Wealth Advisor at Halbert Hargrove
Embarking on the journey of homeownership brings with it a multitude of financial decisions, with one of the most pivotal being whether to prioritize paying off your mortgage early or investing surplus income in the pursuit of other goals such as retirement. While the best choice hinges on individual circumstances, having a comprehensive understanding of the potential benefits and pitfalls of each path can guide you to making an informed decision.
Evaluating Financial Stability
Before you decide whether to either pay off your mortgage early or invest , it is imperative to gauge your financial stability. Begin by e nsuring that you have an emergency fund in place and are also not burdened with high-interest debt (such as credit card and/or student debt). Once these bases are covered, you may consider the following strategies to decide whether or not to make extra payments to pay off your mortgage early is the right choice for you:
Strategy 1: Accelerated Mortgage Payoff
Pros
- Interest Savings: By paying off your mortgage earlier than its term, you can most likely save a substantial amount on interest payments over the remaining life of the loan. (Mortgage Calculator)
- Peace of Mind: Owning your home outright free and clear of a mortgage can offer a great sense of financial and psychological security , reducing financial stress – especially if done before you enter full retirement.
- Protection Against Variable Expenses: If your mortgage has an interest rate that can vary in the future then it’s very likely that paying it off sooner will spare you potentially higher amounts of interest to pay should the interest rate actually increase in the future.
- Improved Cash Flow: Once the mortgage is paid off, your household monthly expenses should decrease, freeing up cash for other purposes. It’s the equivalent of a tax-free increase in your monthly cash flow which can be used for pursuing other goals.
Cons
- Missed Investment Opportunities: Directing surplus income towards your mortgage means missing out on potential investment opportunities that might have offered higher returns.
- Reduced Liquidity: Making extra payments towards your mortgage reduces your liquidity since it’s not easy to access the equity in your home quickly.
- Elimination of Tax Write O ff: A percentage of home mortgage interest can be deducted from federal and state taxes (if you itemize your deductions) so paying your mortgage off early removes that write off
Strategy 2: Investing Surplus Income
Pros
- Potential Higher Returns: Historically, investments, particularly in the stock market, have offered higher returns compared to the interest saved on a mortgage.
- Compound Growth: Investing allows you to benefit from compound growth, where your investments generate earnings that are reinvested to generate their own earnings.
- Diversification: Investing enables you to build a diversified portfolio, spreading risk across different asset classes.
Cons
- Market Risks: Investments come with inherent market risks, and there’s no guarantee of positive returns.
- Investment Costs: Investing also involves costs such as brokerage fees, fund management fees, and potential tax implications.
Tailoring the Strategy to Your Circumstances
Making the right choice necessitates a careful consideration of your individual circumstances. Here’s a framework to use for how you can approach this to make the best decision:
- Risk Tolerance
Evaluate your risk tolerance. If you are risk-averse, paying off your mortgage might align more with your comfort level.
- Interest Rates
Compare the interest rate on your mortgage with the expected return on investments. If the expected return on investments is higher, it might be worthwhile to consider investing.
- Tax Considerations
Consider the tax implications. Sometimes, mortgage interest can be tax-deductible, while investments might have capital gains tax implications.
- Retirement Planning
Consider your retirement planning. If you are nearing retirement, reducing debt might be a priority, whereas if retirement is far off, investing for the long-term could be more beneficial.
- Pursuit of Other Life Goals
Similar to the previously-mentioned item, consider your other important life goals which perhaps may include savings for college for children or taking a long-sought trip. Will paying your mortgage off earlier prevent you from attaining any of these other goals? Ideally, closing out your mortgage will neither stop nor significantly slow your progress towards attaining these other goals.
6. Consult a Financial Advisor
Consulting with a financial advisor can provide personalized advice based on your unique financial situation.
The Bottom Line: Pay Off Mortgage Early or Invest?
Whether to pay off your mortgage early or invest is a decision that should be grounded in a comprehensive evaluation of your financial circumstances, goals, and risk tolerance. By considering the pros and cons associated with each strategy, along with your individual situation, you can make a decision that aligns with your long-term financial well-being. Remember, the right choice is one that not only makes mathematical sense but also aligns with your peace of mind and financial security. Explore more guidance and tailor-made solutions at Halbert Hargrove Financial Planning Services.
Disclaimer:
Halbert Hargrove Global Advisors, LLC (“HH”) is an SEC registered investment adviser located in Long Beach, California. Registration does not imply a certain level of skill or training. Additional information about HH, including our registration status, fees, and services can be found at www.halberthargrove.com. This blog is provided for informational purposes only and should not be construed as personalized investment advice. It should not be construed as a solicitation to offer personal securities transactions or provide personalized investment advice. The information provided does not constitute any legal, tax or accounting advice. We recommend that you seek the advice of a qualified attorney and accountant. All opinions or views reflect the judgment of the author as of the publication date and are subject to change without notice. All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted.
