If you own a home, and come into some extra cash, you might be tempted to put that money into your mortgage so that you can pay off your house early — an excellent goal that will reduce the interest you owe over time and possibly even your monthly mortgage payments.
However, is this the wisest thing to do with your cash? Financial expert Jaspreet Singh, an entrepreneur, licensed attorney and founder of “The Minority Mindset” YouTube channel, discussed in a recent video the pros and cons of using extra money to pay down your home.
Mortgages are Front-loaded in the Bank’s Interest
Singh is careful to recommend that no financial advice is one-size-fits-all. He always asks: what is the best investment for you depending on your goals?
To get started looking at the pros and cons of paying off your mortgage early, he laid out some numbers as a baseline. He made it clear that in the first half of your loan term, your mortgage is front-loaded so that a higher percentage of each payment goes to the bank as interest, and a lot less goes to your loan principal.
Using a 30-year fixed-rate loan with a 6% interest rate for $500,000 beginning in January 2023 as an example, he demonstrated that of your monthly payments of approximately $3,000 per month, or $36,000 in one year, you’d only be paying about $5,600 to your principal loan, and the remainder as interest the bank. That’s a staggering amount of money lining the bank’s pockets and not paying down your loan. It wouldn’t be until approximately October of 2036 that you’d begin to see the bulk of your payments going to pay down your principal.
That might light a fire under your butt to pay your home down faster. However, he said, you might want to consider your options first.
Investing Extra Cash Instead
Singh posed an alternative: What happens if you invest any extra money instead? If you were, for example, to invest $5,000 and turn it into $10,000 or $20,000, then even if you’re helping to line your bank’s pockets in interest with an extra mortgage payment, it’s worth it because you made extra money through investing.
To simplify: If the interest rate on your home is less than the interest rate from your investment, it makes sense for you to invest your money, get a better return and use those profits to pay down home mortgage at a profit rather than simply investing your extra $5,000 in the home.
Risk Tolerance and Financial Goals
Of course, there’s a catch when it comes to investing. It comes with greater risk than paying down a mortgage. The average stock market return is around 10% a year, but that’s just an average. There’s no guarantee. Some years it may be lower, other years higher. You might lose money investing, whereas paying off your mortgage is a guaranteed return because it saves you on interest.
How do you find the right answer? You have to determine your financial goals and risk tolerance.
Perhaps your financial goals are simpler. Maybe you want to live small and not stress so much about making mortgage payments, and you don’t want to take on a lot of risk. In that case, Singh pointed out that if you pay off your home quicker, you’ll reduce your biggest expense.
If your financial goal is to live a bigger or lavish life, to buy more expensive things, and you have a willingness to take on more risk, it may be better to invest any extra cash instead of paying down the mortgage.
If You Have High-Interest Debt
If you are carrying high-interest debt, such as credit cards or a home-equity line of credit, which often have interest rates as high as 16%, Singh said it would be beneficial to pay that off instead of a mortgage, as your mortgage interest rate should be vastly lower than 16% per year.
If You Are Having Trouble Paying Bills
If you’re having trouble affording both your mortgage payment and your credit card debt and you have to choose, Singh said you may want to pay off a home sooner, because then you have the security of a stable place to live, whereas you can declare bankruptcy to deal with credit card debt. However, declaring bankruptcy can also ruin your credit score.
So You’ve Decided To Pay Off Your Home
If you do, ultimately decide to pay more money toward your mortgage with extra cash, Singh cautioned that you should make sure you’re doing it correctly.
Ideally, you should make an additional payment separate from your regular mortgage payment, and specify that this payment should go toward the principal and not toward the following month’s bill. Make sure you can clarify with your lender that your extra payment is to be applied only to principal.
If You Want to Invest Like Jaspreet
If you do opt to invest, and you want to do it like Singh does, he invests in five main ways:
- He owns his own business, which he works on growing.
- Real estate: Primarily apartment complexes to rent out for consistent cash flow.
- Stocks: Individual companies and ETFs funds.
- Physical gold: Physical gold retains its value better than paper money.
Singh sees himself as a long-term investor, not a trader, and suggested that a certain amount of financial education comes through trial and error. But you should always consult a professional if you are unsure.
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