Monday, April 28, 2008

Investment or Mortgage

I had a conversation with a friend this morning about how poorly our 401ks have faired this year. Although they are almost breaking even for the year, the market volatility had me thinking...

One of the popular questions people ask is whether it is better to push money into investments or on to your mortgage. Some financial advisers will tell you to put it into investments which will get you 8-10% while you only pay 6% on your mortgage. Others will point out the tax advantages of the interest on your mortgage, while ignoring the tax implications on your investments. Either way, working out the numbers you can make more if you assume an 8-10% return than you spend would on a 6% mortgage.

Other financial advisers, like popular anti-debt talk show host Dave Ramsey, will tell you to fully fund your 401k and Roth IRAs before paying off your mortgage. Fully funding, according to Dave Ramsey, means 15% of your gross income towards Roth IRAs and your pre-tax retirement accounts like IRAs and 401ks. At that point, he would tell you to put it towards your house debt because you wouldn't take equity out of your home to put it in the stock market, would you? The answer is, you especially wouldn't do so now.

The key is that the 8-10% return on investment is projected and you will not find guaranteed interest higher than your mortgage. The market has proven its volatility this year and you would have struggled to get over 5% back on stocks, mutual funds, through money market/savings accounts, or through CDs/bonds this year so far. Yet, most of us with mortgages have primary mortgages somewhere between 5-7% with some secondary mortgages from 7-10%. So far this year, paying off your mortgage would have been the better financial decision. In the end, paying down your house also brings more financial stability to your family and more freedom overall.

An executive who I reported to around 2004-2005 when hearing I was purchasing a house made the comment that he hopes it was a big mortgage, cause "thats how we lock in our employees." Was he joking? He said it jokingly, but there was some truth behind that joke. Many people rely on their salaries to pay their mortgages and couldn't take a pay cut. If you had your house paid off, you might be able to support your family while working a lower paying job. That helps financial stability. Also, you might be able to choose to do something you love rather than what you put up with. :-)

Finally, imagine what you can do with an extra mortgage payment in your pocket every month. Let's say you have a low mortgage payment of $1000 per month. If you could invest that over the next 10 years instead of use it to pay off your mortgage, in 10 years at 10% annual return your would have over $205,000. Try it with your mortgage numbers using this Investment Calculator.

As my friend concluded our conversation today, "That guaranteed 8% by paying down my [second] mortgage is sounding pretty good about now."

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