Properties are investments, but they come with a long-term cost. While mortgages have set terms, you could opt to pay them off faster. If you have a typical fixed-rate mortgage, you have the option to pay more now. That way you have the option of paying less later.
There is, however, one downside to overpaying on your mortgage payments. By doing so, you’re forgoing on other opportunities to invest in your future.
You typically can’t lose out by paying your mortgage off faster. But mortgages reward you better for paying off your mortgage promptly. So, let’s go over when it’s best to pay more off your mortgage and when it’s best to make other investments.
Overpaying Your Mortgage
Mortgage payments are a long-term burden that can drag your investment potential down. So, it makes sense that you would consider paying it back sooner. But before you start chipping more off your mortgage, it’s best to learn what goes into a typical mortgage.
The Typical Mortgage repayment Process
Most mortgages in the US are fixed-rate and paid back over a term of 30 years.
If you have this kind of mortgage, these are the factors that go into your repayments:
- Interest (the rate you’re charged for borrowing the money)
- Principal (the money borrowed before interest)
- Homeowner’s insurance
- Mortgage insurance (when applicable)
A fixed-rate mortgage’s repayments start by going more towards interest than principal. So, in the earliest phase of your mortgage, you save more money long-term by overpaying. It doesn’t matter if you have a conventional mortgage or a government-backed one.
During the later part of a fixed-rate mortgage, the opposite is the case. If you’re in the latter third of the term of your mortgage, your repayments are going more towards paying off your mortgage’s principal.
So, you always save more by overpaying on your mortgage earlier rather than later. On top of that, consider the fact that by overpaying earlier, you’re reducing your mortgage’s principal as well. That means you’re cutting off the basis for even more interest down the road.
If you want to overpay on a fixed-term mortgage, the earlier you can do so, the better.
But What If I Have an Adjustable-Rate Mortgage?
Paying more earlier isn’t always best with adjustable-rate and other non-standard mortgages. Paying more of your mortgage off, even if it’s later in the term, is better. Also, you can build more equity in your adjustable-rate-mortgaged home. That way it will be easier to refinance to a fixed-rate mortgage later.
What About Investments?
Regardless of when you choose to set aside more money for mortgage payments, you’re always losing out on the opportunity to invest. This is particularly true nearing the very end of your mortgage. At that point, you can typically earn more through investments than you would lose by not overpaying on your mortgage.
When weighing how much your mortgage costs vs how much you can make by investing, remember that mortgage interest is different from other debt interest when it comes to paying taxes. If you itemize your deductions on Schedule A of your Form 1040, your mortgage interest is tax-deductible.
Holding Your Mortgage To Focus On Investing
Prioritizing investing offers one clear advantage:
You’re not just shaking off debt, you’re building your liquid assets.
This benefit cannot be overlooked or understated. If you can manage to maintain even a 7% annual return, that’s a pretty good return. You will often be able to make more from investing than you save by paying more on your mortgage.
The only problem here is that it takes time to reap the rewards of investing. But it also takes time to pay off a mortgage. But if you invest in retirement accounts for a long time, you are very likely to end up with more money than you would have saved by focusing on your mortgage.
So, What Should I Focus On?
Financial planner Brian Fry laid out a good rule of thumb:
If you stand to make more money through your investments than you pay in mortgage interest, it’s better to invest. But if your mortgage interest costs more than your investments’ net profits, it’s best to focus on your mortgage.
There are no guarantees with investments. But your best bet should you choose that route are safer bets like index investing. Short-term investments that you aren’t experienced with are more likely to lead to undesirable results. They also don’t allow your portfolio enough time to recover in the case of downturns.
The key is, as we’ve focussed on, to not allow your investment gains to fall short of your mortgage repayments. So, it will often make sense to focus on your mortgage until you can safely shift to investing without your mortgage being too much of a burden.
Your decision should start with the consideration of your interest repayments. Then, you can switch to focussing on your wider investment portfolio.
Lastly, you could simply refinance your mortgage. If you can gain lower interest rates by doing so, you will have more space to invest in your future.
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