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Even if you are a happy homeowner, you most likely detest the idea of having to pay a mortgage for the ensuing few decades. However, given how well the stock market has been doing recently, you might feel as though you’re losing out on opportunities because you’re not investing more.
Thus, what’s the best course of action: Should you invest your excess money or pay off your mortgage early? Here are some things to consider.
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Choosing between investing in your 401(k) and paying off your mortgage can be a tough decision. Both options have their own advantages and disadvantages, and the best choice for you will depend on your individual circumstances.
Here’s a breakdown of the pros and cons of each option:
Investing in your 401(k):
Pros:
- Tax savings: Contributions to your 401(k) are typically made with pre-tax dollars, which means you don’t have to pay taxes on that money until you withdraw it in retirement. This can save you a significant amount of money in the long run.
- Employer matching: Many employers offer a matching contribution to their employees’ 401(k) plans. This is essentially free money, so it’s always a good idea to take advantage of it.
- Compound interest: The money you invest in your 401(k) will grow over time thanks to compound interest. This means that your earnings will earn interest, which will then earn more interest, and so on. This can help you accumulate a significant amount of wealth over time.
Cons:
- Risk: The stock market can be volatile, so there is a risk that your investments could lose value. However, over the long term, the stock market has historically trended upwards.
- Limited access: You won’t be able to access the money in your 401(k) without penalty until you reach retirement age (59 1/2).
Paying off your mortgage:
Pros:
- Reduced interest payments: The sooner you pay off your mortgage, the less interest you’ll have to pay over the life of the loan. This can save you a significant amount of money.
- Increased equity: As you pay down your mortgage, you’ll build equity in your home. This equity can be used to secure a home equity loan or line of credit, or it can simply provide you with peace of mind knowing that you own your home outright.
- Guaranteed return: Paying off your mortgage is a guaranteed way to earn a return on your investment. The return you’ll earn is equal to the interest rate on your mortgage.
Cons:
- Opportunity cost: If you choose to pay off your mortgage early, you’ll be giving up the opportunity to invest that money elsewhere. This could mean missing out on potential gains in the stock market.
- Loss of tax deduction: If you itemize your deductions on your tax return, you may be able to deduct the interest you pay on your mortgage. However, if you pay off your mortgage early, you’ll lose this tax deduction.
Ultimately, the best decision for you will depend on your individual circumstances. If you’re young and have a long time horizon, you may want to prioritize investing in your 401(k). However, if you’re closer to retirement or have a high-interest mortgage, you may want to focus on paying off your mortgage first.
Here are some additional factors to consider:
- Your risk tolerance: How comfortable are you with the possibility of losing money on your investments?
- Your financial goals: What are your long-term financial goals?
- Your current financial situation: How much debt do you have? How much money do you have saved?
It’s a good idea to talk to a financial advisor to get personalized advice on which option is best for you.
Frequently Asked Questions (FAQs)
What is a 401(k)?
A 401(k) is a retirement savings plan offered by many employers. It allows employees to contribute a portion of their paycheck to a retirement account on a pre-tax basis. The money in the account grows tax-free until it is withdrawn in retirement.
What is a mortgage?
A mortgage is a loan that is used to purchase a home. The borrower agrees to repay the loan, plus interest, over a period of time.
What is compound interest?
Compound interest is interest that is earned on both the principal and the interest that has already been earned. This means that your earnings will earn interest, which will then earn more interest, and so on. This can help you accumulate a significant amount of wealth over time.
What is equity?
Equity is the difference between the value of an asset and the amount of debt that is owed on it. For example, if your home is worth $200,000 and you have a mortgage of $100,000, then you have $100,000 in equity in your home.
What is a home equity loan or line of credit?
A home equity loan or line of credit is a loan that is secured by the equity in your home. This means that if you default on the loan, the lender can foreclose on your home.
What is a financial advisor?
A financial advisor is a professional who can provide advice on financial matters, such as investing, retirement planning, and estate planning.
Additional Resources
- Internal Revenue Service (IRS)
- National Association of Realtors (NAR)
- Consumer Financial Protection Bureau (CFPB)
Choosing between investing in your 401(k) and paying off your mortgage is a personal decision. There is no right or wrong answer, and the best choice for you will depend on your individual circumstances. Consider your risk tolerance, financial goals, and current financial situation when making your decision. It’s also a good idea to talk to a financial advisor to get personalized advice.
Pros and Cons of Paying Off Mortgage Early
Generally speaking, investing is a better financial move than setting aside additional funds to pay off your mortgage sooner. Of course, life isn’t just about cold, hard numbers. There are numerous reasons why you could decide to increase your investments or make an early mortgage payment.
Here are a few explanations for why you might want to think about paying off your mortgage early, or not.
- Interest savings: One of the main advantages of early loan repayment is this. Interest payments could be reduced by several thousand or tens of thousands of dollars. Early mortgage payments result in interest savings that ensure a return on your investment.
- Peace of mind: Early mortgage repayment can lessen your burden if you don’t like the idea of being in debt all the time. Having a paid-off home eliminates the worry of missing mortgage payments and possibly losing the property to foreclosure in the event of a financial emergency. As long as you own the house, you will still be accountable for property taxes, but that will be a far smaller financial burden.
- Build equity: Reducing your mortgage faster allows you to accumulate equity in your house faster. You may be able to qualify for refinancing as a result, which could ultimately result in even greater cost savings. In order to make improvements that raise the value of your house or pay off other debt with higher interest rates, you might also be able to leverage your equity through the use of a home equity loan or home equity line of credit (HELOC).
- Opportunity cost: Any additional funds you use to accelerate your mortgage repayment are funds you aren’t able to use toward other financial objectives. It’s possible that you’re paying off your mortgage early at the expense of other higher-returning investments, retirement savings, or emergency fund.
- Wealth is linked: Real estate is an illiquid asset, which means it is difficult and takes time to convert into cash. You would have to wait until a buyer was found and the sale closed if you were in financial danger or wanted to take advantage of an investment opportunity.
- Loss of certain tax benefits: You will forfeit those tax benefits if you decide to pay off your mortgage rather than filling up all of your tax-favored retirement accounts. Additionally, if you typically itemize your taxes, you might miss out on the mortgage interest deduction.
Pros and Cons of Investing
Investing your excess money has advantages and disadvantages compared to paying off your mortgage early. Here are the main ones to consider.
- Increased returns: The ROI is the primary advantage of investing your money as opposed to using it to pay down your mortgage more quickly. You stand to benefit greatly from the difference because average stock market returns have been much higher than mortgage rates for a number of years.
- Having your money invested in stocks, bonds, and other market instruments allows you to easily sell and access it when needed, unlike owning a home that ties up your wealth.
- Employer match: If you decide to invest your excess money in a retirement account and your employer contributes a match, you will receive additional free money that will grow in value over time thanks to compound interest. Additionally, you would be investing with pre-tax money, which might enable you to make larger contributions.
- Greater risk: Year over year, the stock market is more volatile than the housing market, so you should make sure your investing timeline is long enough to withstand ups and downs. Additionally, you should ensure that your investment strategy is in line with your risk tolerance and that you are emotionally ready to absorb some setbacks.
- Increasing debt: If you don’t like the idea of having debt attached to your name, investing your money might not be the best course of action. You don’t truly own your house until your mortgage is paid off; the bank does. Additionally, there’s always a chance that you won’t be able to afford your house if you can’t make the payments.