Should You Pay Off Your Mortgage Early Or Invest Your Extra Funds?

If you finally get a little breathing room in your budget, you may find yourself with some extra money at the end of the month. Should you invest those extra funds or start to paying off your mortgage early? Many professional money managers have weighed in on this debate with mixed results and recommendations.

Here is a breakdown of the two options with some math to help:

If You Pay Off Your Mortgage Early

Most mortgages allow people to prepay the principal balance without any penalties. Paying just a few extra hundred dollars per year can shave years off of a traditional thirty year fixed rate mortgage.

For example, if you add one extra principal payment on your mortgage every year, or one twelfth of your payment each month, you can help you pay off a thirty year fixed rate mortgage in as little as twenty five years. That equals a savings of almost $50,000 in interest payments that you would have incurred otherwise. Adding as little as $100 extra to your monthly mortgage payment will save you an incredible amount of money over the course of your loan.

Another popular method to pay off your mortgage is by making bi-weekly payments. Many banks are even offering this option directly on their websites and through forms you fill out at closing.

Since there are 52 weeks in a year, you will make 26 bi-weekly payments or 13 months worth of payments in a twelve month calendar year. The problem with this method is the potential havoc it could place on your household budget if you are not careful. You will find yourself making three mortgage payments in a month during some months.

A $250,000 home mortgage with a thirty year fixed rate mortgage (4.53% APR) can be paid off in as little as twenty-five years for a total savings of over $35,000 in interest payments over the course of the loan.

If You Invest Before You Pay Off Your Mortgage

If you only pay your monthly minimums on your mortgage and invest what you would have used to pay off your mortgage early, that one extra payment per year ($1,271)would grow to $143,000 in thirty years when you were done paying your mortgage.

However, you will have paid your entire mortgage, including the principal and interest payments, for the entire year. If you never added to your investment after finishing your thirty year mortgage, your nest egg of $143,000 could continue to grow to approximately $422,000 by the age of 65.

Investing Generates More Money Than a Paid Mortgage

There is one hidden benefit to paying off your mortgage early. Once you are finished paying off your loan, you will have a dramatic increase in your cash flow. You could continue making your mortgage payments, but instead of making the payments to the bank, you make them to yourself. You now have that money every month to invest.

If you pay off your mortgage five years early by the age of forty-seven (assuming you bought your home at age 22), for example, you could invest that extra $12,000 per year for the next five years. You were just going to pay it to the bank anyway. Now, you can invest it instead. If you made mortgage payments to yourself for five years and then just let the account sit and grow, you would have over $206,000 fourteen years later when you retired at age 65 (assuming an 8 percent annual return) and a paid off house.

I am a personal fan of both options. I want to pay off my mortgage early, but I do not want to delay investing either. The math has shown that paying off your mortgage alone does not equal the same savings that you would enjoy if you used that money to invest at an early age. Time is an investor’s biggest advantage because you can harness the power of compounding interest. Investing consistently over a long time can be a greater benefit to many home owners than paying off your mortgage early.