🏠Payoff Mortgage & Refinance or Invest and Keep? The Crazy Calculation Behind The Tough Decision

One is predictable, the other isn’t.

A mortgage payment is comprised of two parts: repayment of principal/face/par value and nominal/coupon/ interest rate expense that is charged by a financial institution (bank) holding your mortgage (debt security/loan) until it’s paid off at maturity. This is a stagnant payment that doesn’t change, whether you move out or not and or refinance. You still have it looming over your shoulders as a liability.

On the other hand, investing in the market comes with risk of losses and underperformance. No matter how superb your judgement and track record may be, no one has a crystal ball.

There’s no return taking out a mortgage and a 50/50 chance an investment will grow or fail. FYI, investing in a high-flying stock you haven’t done any research on isn’t investing. It’s trading or what I like to call speculating. You can’t invest without trading but you can trade without investing.

If you can’t handle the risk of losing a large percentage of your portfolio while still having to pay off your mortgage, it may be safer for you to just pay off the mortgage and save.

Ultimately, if you believe the investment will give you a higher net after-tax return than your net interest cost on your mortgage, it could be wiser to invest.

Home-Ache

Paying off your mortgage is a source of debt and major liability that accumulates over a few years, most commonly set at 15 or 30. Whether you choose to get a fixed versus conventional/ARM(adjustable rate) mortgage where interest payments fluctuate depending on the economic environment as opposed to the rate staying stagnant is your choice but doesn’t always reduce costs.

This is a sticky situation that homebuyers get themselves into. Considering that the average homeownership tenure is roughly only 3–5 years instead of the recommended 8–10 to earn decent cash flow and capital gains/unrealized gains on your home, most residents are loosing and spending more on their home to barely breakeven when it comes time to sell.

A house isn’t considered an asset at the time of purchase. From location, to renovation, non-refundable costs, maintenance, down payment and don’t forget that pesky mortgage, all of these expenses eat into your home’s price and could easily cost you more than what you paid for. In this case, an asset is a tangible physical investment that appreciates overtime. Time is your biggest advantage to growing wealth and preserving capital. Even if you kept your home and were able to pay the monthly maintenance and mortgage during the Housing Crisis of ’08, your home would have gained at least 20% till today as home prices are up nearly 11% since last year. Yet although most land is scarce and has a high intrinsic value that will go up overtime, after all the money spent on the house only residing there for a few years, it may not generate a profitable return.

There are certainly pros and cons to taking out short vs long term mortgages. Most notably, longer-term mortgages have higher interest payments since the loaner believes there is less of a chance the borrower (homeowner) will pay back overtime.

Longer maturities = larger interest payments.

Since we are now in the thrust of a speedy recovery, inflation looks heated and the Fed is bound to taper off rates any moment, the yield curve, which is directly correlated to the 10 year yield which indicates how investors are buying/selling bonds and how the economy is doing, is currently moving towards a nominal, positive direction which means shorter term mortgages are more attractive.

Hassle

Mortgages are pure hassle and another thing to worry about as a homeowner. Most homeowners cannot afford their home in the first place and have to take on debt. Yet, taking out a mortgage isn’t necessarily a bad thing especially if your budget, let’s say is around $5m-$10m. To grow your investments you must take on calculated risk and that usually requires taking on debt.

Paying that much in cash is nonsense unless there are many high bidders and in that case your cash offer would take precedence. Plus if your net worth is at least $20m, you are able to allocate at least $1m in cash since 20% of your net worth in cash is recommended.

The recommended cash deposit amount is 20%+ yet majority of homeowners especially those attempting to snag a deal which frankly isn’t possible in this overheated bubble market, are putting less and less down around 5–10% concerning banks that they won’t be able to pay and default leading to possible haunted foreclosure. Fortunately institutions have learned their lesson after faulty mortgage borrowing from 08′ and have tightened restrictions on lending. Creditworthiness with an above average credit score in the 700’s and above is ideal to be able to get your foot in the door. No pun intended.

Compared to other forms of debt such as consumer credit card debt or a car loan, a mortgage helps you attain and preserve capital in your home while building utility and possibly passive income if you choose to rent it out.

Critics of a mortgage say yay to rent and nay to buy. No doubt renting is cheaper but the biggest decision maker between renting or buying should be your estimated time span. If you plan on living in the residence for more than 5 years, renting is money down the drain especially since it already provides a -100% return the moment you step foot in the door.

If you decide to buy instead of rent to diversify your portfolio and build equity in your home, to get the best deal on a mortgage, take one out when interest rates are at rock bottom before the Fed ends bond buying and pushing stimulus into the economy.

Reasons to Pay Your Mortgage Earlier vs. Invest

Benefits of Paying Off Your Mortgage Early

Interest savings: This is one of the biggest benefits of paying your loan off early. You could save thousands or tens of thousands of dollars in interest payments. When you pay your mortgage early, those interest savings are a guaranteed return on your investment.

Peace of Mind: If you don’t like the idea of constant debt, paying your mortgage early could ease your burden. If you experience a financial emergency, having a home that’s already paid off means you don’t have to worry about missing mortgage payments and potentially losing the home to foreclosure. You still will be responsible for property taxes as long as you own the home, but that’s a much smaller financial responsibility.

Build equity: Paying down your mortgage faster means building equity in your home more quickly. This can help you qualify for refinancing, which can save you even more money in the long run. You may also be able to leverage your equity in the form of a home equity loan or home equity line of credit (HELOC), which you can use to make improvements that increase your home’s value or pay off other higher-interest debt.

Drawbacks of Paying Off Your Mortgage Early

Opportunity cost: Any extra money you spend on paying down your mortgage faster is money you aren’t able to use for other financial goals. You may be paying off your mortgage early at the expense of your retirement savings, emergency fund or other higher return opportunities.

Wealth is tied up: Property is an illiquid asset, meaning you can’t convert it to cash quickly or easily. If you faced a financial emergency or had an investment opportunity you wanted to jump on, you’d not only have to sell your house, but also wait until a buyer was available and the sale closed.

Loss of some tax breaks: If you choose to pay down your mortgage instead of maxing out your tax-advantaged retirement accounts, you will give up those tax savings. Plus, you may lose out on tax deductions for mortgage interest if you normally itemize.

Benefits of Investing Your Extra Cash

Higher returns: The biggest benefit of investing your money instead of using it to pay down your mortgage faster is the ROI. For many years, average stock market returns have been significantly higher than mortgage rates, which means you stand to gain quite a bit from the difference.

Liquid investment: Unlike a home that ties up your wealth, having your money in stocks, bonds and other market investment means you can easily sell and access your money if you need to.

Drawbacks of Investing Your Extra Cash

Higher risk: There is more volatility in the stock market than in the housing market year over year, so you should be sure your investing timeline is long enough to weather ups and downs. You also need to make sure that your investment strategy matches your risk tolerance and you’re mentally prepared to take some hits.

Increased debt: Choosing to invest your money may not be the best option if you don’t like the idea of having debt under your belt. Until your mortgage is repaid, you don’t actually own your home — the bank does. And there will always be some risk that you could lose your home if you aren’t able to make the payments.

Stuck

If you’re still on the fence about which option is best for you, you’re in luck! You don’t necessarily need to choose between paying off your mortgage early or investing. Rather you can reduce your debt, save and grow your wealth at the same time.

With mortgage rates at historic lows, this is a great time to refinance, although not always the best choice since you are still paying interest and the bank is redirecting a new loan to you which means a new set of juicy closing costs and time waisted.

Don’t forget time = money!

Taking advantage of the stock market is a must especially during the longest bullish rally we’ve had for 10+ years and as the 10-year treasury yield inches higher and moves towards fixed income safer securities such as bonds, getting invested to earn that high yield on your savings is key.

Bottom line, your choice depends on your situation and current interest rates. The biggest factor in deciding whether to pay off a mortgage early or invest your extra cash from a windfall, salary raise, bonus or some other source of income is the economy’s outlook.

Decide if you plan to stay in your home up until your mortgage expires or not. If so, refinancing won’t be as expensive since you’ll be building equity in your home overtime yet if you plan to move soon, keep paying off that interest rate responsibility and earn some additional income on the side to invest or plan for other short/long term needs from retirement to your child’s college savings. There’s always something you can fund!

What works for you may not work for someone else.