Many individuals wonder whether it would be more beneficial to overpay their mortgage or invest extra money when they have some left over. This is a common question that financial planners often face, especially when mortgage rates are relatively high, typically around 6% to 7%. The decision to overpay the mortgage or invest the extra money ultimately depends on an individual’s personal situation and financial goals. Providing examples with numbers can help illustrate how this decision may play out for each individual.
Using an example where an individual owns an $800,000 home with $400,000 remaining on the mortgage at a 5% rate for 30 years, and has $1,000,000 saved for retirement, can help shed some light on this dilemma. In this scenario, many financial planners tend to believe that over the mortgage term, investments will likely outperform the interest paid on the mortgage. Even if investment returns and mortgage rates were assumed to be identical, investing holds a slight advantage as one can still benefit from the deduction for mortgage interest.
Continuing with the example, over the 30-year mortgage period, an individual would pay a total of $773,023 in interest, in addition to the $400,000 principal borrowed, totaling $1,173,023. However, if that same money was invested monthly at a 5% rate of return, assuming the benefit of compounding interest, the total amount would be $1,757,774. This illustrates how investing the money instead of putting it towards the mortgage can yield greater returns in the long run.
It is important to consider the rate of return when making this decision. Overpaying the mortgage does not increase the value of the home, as appreciation continues regardless of whether money is owed on the property or not. Ultimately, the value of the home is determined by market forces and not by the mortgage owed on it. In order to justify overpaying the mortgage instead of investing extra money, one would need very poor investment returns over 30 years and exceptionally high mortgage interest rates.
It is also crucial to note that while one can borrow money for a home, the same cannot be done for retirement. Investing in the future through retirement savings is essential, and overpaying the mortgage may not provide the same financial security in the long term. Understanding the implications of overpaying a mortgage versus investing extra money is crucial in making informed financial decisions for the future. Researching and consulting with a qualified financial planner can help individuals determine the best course of action based on their individual circumstances and financial goals.
