Inspiration for my blogs comes from many sources. Sometimes I get inspired to write on a topic from a client meeting. Other times, my inspiration comes from something I read or from a conversation in the workplace. Further still, sometimes inspiration comes from a text message discussion with a bunch of buddies who love to debate. (So, thank you O-man, Fertig, H, & Dbav. I hate to give them any credit, because it will go to their already inflated egos. But hey, what can you do?)
The other day through text, Fertig threw this softball question out there. Should he overpay his mortgage or invest those dollars elsewhere? At a roughly 4% interest rate, it is a very good and logical question. It’s one clients often ask, too. In most cases, it’s situational upon each individual’s financial plan. However, I thought it would be fun to write a two-part article debating both sides of this question. (I’ll end part two with what I am currently doing, so keep reading!)
To begin, I’ll start with NOT overpaying your mortgage.
For this debate, it also makes sense to stick with some standard assumptions. Let’s assume a 30yr mortgage at a 5% or under interest rate; this represents the majority of individuals with mortgages these days.
10 reasons NOT to overpay your mortgage:
1. You can invest those dollars elsewhere (like in the stock market). In doing so, you’ll earn a better rate of return on your money than your current mortgage interest rate. There are no guarantees on your return, but if you believe in the long-term trend, your investments should outperform your mortgage interest rate.
2. You are an aggressive investor. This goes hand-in-hand with reason one. Typically, a more aggressive investor has higher return potential, although they’ll experience more volatility. Since we are talking about a 30-year time span, one can assume the risk of investments has a good probability of paying off.
3. Liquidity is important. Some individuals need more liquid assets–like stocks or mutual funds. A mortgage, however, is a debt with lesser liquidity.
4. Other parts of your financial plan are behind schedule. For many of us, this decision isn’t binary; it isn’t an option: A) investing or option B) overpaying. There are other issues at play, such as retirement savings, college savings, or even having the appropriate amount of life insurance in place. For these individuals, I would much rather see them correct an issue than overpay a fixed debt.
5. You have a ridiculously low-interest rate. For those reading this who owned homes in the ’70s & ’80s, do you remember when mortgages were around 12% interest rate? Oy vey! Today, it isn’t uncommon to see someone with a 3% interest rate. Assuming these individuals are on a path to paying off their mortgage in a timely fashion, why overpay a cheap loan? A wise man once told me you get rich by using other people’s money.
6. You have other debt obligations. This one is very common. Many of you have outstanding college loans or other high-interest debts, like credit cards. You may be better served by addressing these more debilitating debts instead.
7. Your mortgage will be paid off before retirement. The biggest benefit to overpaying your mortgage is not having this obligation in retirement. If your mortgage is already on track, there is a strong argument for putting your dollars elsewhere to better secure your financial future.
8. You still itemize deduct. With the tax law changes, you might still find yourself itemizing your deductions. If so, then you still get a nice tax benefit for your interest payments. As a matter of fact, your already low rate is effectively even lower due to the fact you get an interest deduction against your income. (I have a sneaky suspicion you’ll see a counterpoint to this in part two.)
9. You plan to move in the (relatively) near future. In this instance, overpaying your mortgage is giving money to a bank with no interest when returned to you. Think about that for a second! You put $5,000 extra towards your mortgage and you still pay your normal payments with interest rates (granted, it’s slightly less interest per payment). When you sell that house, you’ll get that same $5,000 back. There is no real return on your efforts.
10. You have strong job security. Why does this matter? Let’s say you are a doctor or a teacher; these professions (and several others like them) usually have a high amount of job security. There isn’t a lot of concern you’ll wake up tomorrow out of a job. For these individuals, getting rid of a fixed expense isn’t as big a concern. Since they also have a predictable fixed-income to rely on, they can often focus their efforts elsewhere.
The great “should I overpay my mortgage” debate:
As you can see, there are plenty of reasons NOT to overpay your mortgage. However, you’ll find in part two there are plenty of reasons TO overpay that mortgage as well. It’s situational and continues to be a great debate (which is great news for my texting buddies).
If you find yourself unsure of what to do, I suggest reading part two. After that, by all means, give me a call to discuss further!