| How Much $100,000 Can Potentially Earn in 10 Years |
|---|
| Invested Amount | Years | Rate of Return | Investment Gain |
|---|
| $100,000 | 10 | 2% | $22,019 |
| $100,000 | 10 | 5% | $62,889 |
| $100,000 | 10 | 7% | $96,715 |
| $100,000 | 10 | 10% | $159,374 |
These investment gains were compounded. Interest was earned on the interest and no money was withdrawn during the 10-year period.
Investment Gains vs. Loan Interest Saved
A homeowner would earn $22,019 based on an average rate of return of 2% if they invested $100,000 rather than use the money to pay down their mortgage in 10 years. There would be no material difference between investing the money versus paying off the 3.5% mortgage based on the $20,270 saved in interest from the earlier loan table.
But the homeowner would earn $62,889 if the average rate of return was 5% for the 10 years. This is more money than the interest saved in all three of the earlier loan scenarios whether the loan rate was 3.5% ($20,270), 4.5% ($28,411), or 5.5% ($37,618).
The borrower would earn more than double the interest saved from paying the loan off early, even with using the 5.5% loan rate, with a 10-year rate of return of 7% or 10%.
Repaying their mortgage rather than investing the money not only saves the borrower the interest they would have paid on the mortgage, but it also frees up money that otherwise would have gone to monthly repayments. This money could also be invested with the same rate of return.
Different investments come with different risks
Each type of investment comes with its own risk. U.S. Treasury bonds would be considered low-risk investments because they're guaranteed by the U.S. government if they're held until their expiration date or maturity. But equities or stock investments have a higher risk of price fluctuations, called volatility, and this can lead to losses.
There's a risk that some or all your money could be lost if you decide to invest your money in the market instead of paying off your mortgage 10 years early. You would still have to make 10 years of loan payments as a result if the investment loses money.
The stock market can provide sizable returns, but there's also a risk of sizable losses. Just as taking on more risk can magnify investment gains, it can also lead to more losses so the market risk is a double-edged sword.
A 10% investment gain isn't an easy goal to achieve, particularly after factoring in fees, taxes, and inflation. Investors should have realistic expectations as to what they can earn in the market.
What the Experts Have to Say
Advisor Insight
Mark Struthers, CFA, CFP®
Sona Financial, LLC, Minneapolis, MN
A lot depends on the nature of the mortgage and your other assets. If it's expensive debt (that is, with a high interest rate) and you already have some liquid assets like an emergency fund, then pay it off. If it's cheap debt (a low interest rate) and you have a good history of staying within a budget, then maintaining the mortgage and investing might be an option.
Some people’s instinct is to get all debt off their plate, but you want to make sure you always have ready funds on hand to ride out a financial storm. So the best course is usually somewhere in between: If you need some liquidity or cash, then pay off a large chunk of the debt, and keep the rest for emergencies and investments. Just make sure you take an honest look at what you'll spend and your risks.
Frequently Asked Questions
What is compounding interest?
Interest "compounds" when it earns interest. Say you invest $100. That money earns you $5 in interest over a period of time. You'll be paid interest on $105 if you leave that investment untouched because the interest is compounded. Interest earned on interest can magnify investment gains. This should be compared to how much interest you'll save if you pay off your mortgage.
How does the tax deduction for mortgage interest work?
The interest you pay on a mortgage loan of up to $750,000 is tax deductible on your federal return subject to numerous rules. The limit drops to $375,000 if you're married and you file a separate tax return.
The loan proceeds must be used to buy or build your main home or a second home, and you must itemize in order to claim this tax deduction. Itemizing isn't always in a taxpayer's best interest because they must forego claiming the standard deduction if they itemize. The standard deduction for their filing status can be more money coming off their taxable income than all their itemized deductions combined.
What are some options other than paying off my mortgage or investing?
You might want to establish the security of an emergency fund to hedge against an ailing economy and to pay your mortgage should you experience financial distress. You might want to save for retirement instead, although this involves investing, too, such as in an IRA or 401(k). You could pay off credit card debt that carries a higher interest rate than your mortgage, particularly if your credit card balances are of a significant amount.
The Bottom Line
It's important to consider the interest rate, the remaining balance, and how much interest will be saved before you decide to pay off a mortgage loan early. Borrowers can use a mortgage loan calculator to analyze the amortization schedule for their loans.
Another important thing to keep in mind is that mortgage interest is tax deductible for many homeowners. Interest paid reduces your taxable income at the end of the year.
Consult a financial planner and a tax advisor before deciding whether to pay off your mortgage early or invest that money. A professional can help you analyze your own personal situation and goals.
FAQs
If it's expensive debt (that is, with a high interest rate) and you already have some liquid assets like an emergency fund, then pay it off. If it's cheap debt (a low interest rate) and you have a good history of staying within a budget, then maintaining the mortgage and investing might be an option.
Is it better to invest money or pay off a mortgage? ›
It's typically smarter to pay down your mortgage as much as possible at the very beginning of the loan to avoid ultimately paying more in interest. If you're in or near the later years of your mortgage, it may be more valuable to put your money into retirement accounts or other investments.
Is it better to pay off primary residence or investment property? ›
Choosing between either paying off a primary home or rental property will depend on which you value most. Paying off your rental can increase your cash flow and equity, but paying off your primary residence secures a roof on your head. Another key factor to consider is the respective interest rates.
Is it better to pay off loans early or invest? ›
If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement. This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt.
What is the average age people pay off their mortgage? ›
But with nearly two-thirds of retirement-age Americans having paid off their mortgages, it means that the average age they have gotten rid of that debt is likely in their early 60s. Stats from 538.com, for example, suggest the age is around 63.
What does Dave Ramsey say about paying off mortgage? ›
The Dave Ramsey mortgage plan encourages homeowners to aggressively pay off their mortgages early, however. One recommendation Ramsey makes is to convert your 30-year mortgage into a fixed-rate, 15-year home loan. Not only will you pay off a 15-year mortgage in half the time, but you'll also pay much less in interest.
Is it financially wise to pay off mortgage? ›
This can be particularly helpful if you have a limited income. You want to save on interest payments: Depending on a home loan's size, interest rate, and term, the interest can cost hundreds of thousands of dollars over the long haul. Paying off your mortgage early frees up that future money for other uses.
Why do they say not to pay off your mortgage? ›
If one of your financial goals is to lower your tax bill, you may want to avoid paying off your mortgage early. The IRS allows you to deduct the mortgage interest you pay from your taxable income, lowering your tax bill. You can take advantage of that deduction for the life of the loan.
Why pay off house before investing? ›
There's a risk that some or all your money could be lost if you decide to invest your money in the market instead of paying off your mortgage 10 years early. You would still have to make 10 years of loan payments as a result if the investment loses money.
Should I pay off my mortgage during inflation? ›
Borrowing money today and paying that same amount back later, when the dollar's value is less, can be a smart strategy. This will have a more significant impact over 30 years versus 15 years. Put time (and inflation) on your side and stretch out your mortgage payments for as long as you can.
Millionaires typically balance both paying off debt and investing, but with a strategic approach. Their decision often depends on the interest rate of the debt versus the expected return on investments.
Are there disadvantages to paying off a mortgage early? ›
The Downside of Mortgage Prepayment
Prepaying your mortgage ties up your funds in your home, potentially leaving you with less liquidity for other financial needs or opportunities.
Should I pay off 4.5% loan or invest? ›
If your interest rate is 4.5% or lower4, you may want to focus on investing. Alternatively, if you have a high interest rate, you'll want to make paying that off a priority. Also, remember that credit cards and personal loans commonly come with high interest rates.
Can a 70 year old get a 30-year mortgage? ›
Thanks to the Equal Credit Opportunity Act, a lender can't discriminate against an applicant due to age, says the Consumer Finance Protection Bureau (CFPB). You could be 99 years old and get a 30-year mortgage as long as you qualify.
Is 50 too old for a 30-year mortgage? ›
If you can demonstrate an ability to repay the loan before you're 75 years old, they will consider your application no matter your age! For example, if you needed to borrow $300,000 and were 50 years old, the standard 30-year mortgage term could be reduced to 25 years and your loan would be approved.
What percentage of people never pay off their mortgage? ›
Similarly, states along the Pacific Coast—where home values skyrocketed during the pandemic—have some of the lowest rates of free-and-clear homeownership among the working-age population. California (22.7%), Washington (22.8%), and Oregon (22.9%) sit at 45th, 44th, and 43rd out of all 50 states, respectively.
Is it better to pay off mortgage or put money into savings? ›
In principle, if you're offered a higher interest rate on a savings account than the rate you pay on your mortgage, it could mean it's best for you to save. However, if you're paying a higher interest rate on your mortgage than you could earn from a savings account, it might be best to pay off your mortgage first.
Is it better to put more money down on a house or pay off debt? ›
It may make more sense to pay off debts if you're holding off on buying and are worried about the rates a lender may charge. Factors such as your credit score and DTI will influence the mortgage rate and terms a lender offers.
How to pay off a 250k mortgage in 5 years? ›
There are some easy steps to follow to make your mortgage disappear in five years or so.
- Setting a Target Date. ...
- Making a Higher Down Payment. ...
- Choosing a Shorter Home Loan Term. ...
- Making Larger or More Frequent Payments. ...
- Spending Less on Other Things. ...
- Increasing Income.
