Invest or prepay your mortgage? If you have a little extra money, would it be better to invest that money or make extra payments on your mortgage? It is an age-old question, one that has been asked by people for hundreds, if not thousands, of years. But in all that time nobody has been able to come up with the answer. The reason this is such a difficult question is because the answer depends on so much more than math.
If we considered only the math, we would be tempted to invest all our money and hold onto the mortgage as long as possible. If you have a mortgage at 6%, you would effectively earn 6% if you made extra payments. But consider that the stock market has returned an average of 10% per year for the past seventy years. Clearly, making 10% is better than making 6%.
But maybe it’s not so clear. Do you know how much the stock market will return this year? Will it be 10%? Probably not. It could be anywhere from -20% to 20%, which is an awful big swing. Your mortgage, on the other hand, is guaranteed to return 6%, if that’s your rate. Which one causes you to sleep better? You also need to consider your gut. Which would make you feel better: owning a big pile of money, or NOT owning a big pile of debt?
If you are like me, having a big pile of money may be too much temptation to bear. If you have a big pile of money, and you spend it, your return wasn’t so great after all. But a mortgage locks up any extra money you send in. The only way to get that money back out is with a messy and expensive second mortgage. And the only people with second mortgages are those who have forgotten how painful the first one was!
In the end, it’s a deeply personal decision. Your situation is very different from your neighbor’s, and your decision needs to be tailored for your situation. But if you consider the math and your gut, and be disciplined with whatever decision you make, it will be hard to go wrong in the end.
This column originally appeared in the February 6, 2008, edition of the Greenhorn Valley View.