Clearing Your Mortgage vs Investing in Stocks
It is often said that the best investment you can make is in real estate. Purchasing a house can save you money and earn you money, and once you clear the mortgage, you’ll have a substantial asset that should be worth a lot more than you paid for it.
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At the same time, however, mortgage interest is high, and even if the house increases in value over the mortgage term, the odds of it earning more than a stock market investment during the same period are pretty slim.
So, does that mean that it’s better to invest in the stock market than pay off your mortgage? Not quite.
It’s actually quite a complicated question and one that needs to be approached from several angles, taking your personal circumstances, mortgage rate, refinance options, and monthly payment in mind to determine if a stock market investment will provide a better rate of return than paying off your mortgage.
Why is a Mortgage a Good Investment?
Before we compare the merits of a well-managed stock investment account with a mortgage, it’s important to understand just what makes both of these options such useful investments in the first place.
First up, it’s the biggest investment of them all, a mortgage.
When you take out a home loan, you’re essentially committing for the next 10, 20 or 30 years to a loan that’s worth more than all the credit cards and personal loans you will ever acquire. It sounds risky, and it is, but it has plenty of merits as well.
Rent is (Somewhat) Wasteful
65% of tenants rent property because they can’t afford to pay for a mortgage and more than a third of all homeowners will rent their property for a profit during a 50-year period. Combine this with the fact that rent has increased significantly and continues to rise, and it’s easy to see why not owning your home could get very expensive very quickly.
As we have discussed before in our guide to buying a home, renting isn’t always as wasteful as you might have been led to believe. In fact, if you take a 5% APR loan over a 30-year term, more than 70% of your monthly payments will go towards the interest, and it’ll take more than 15 years before the split between interest and principal is 50/50.
This also increases the higher your interest rate is, which is why we always recommend biding your time, and not rushing in, because it’s better to spend a few years increasing your down payment and reducing your interest rate (by improving your credit score) than rushing in just so you can start making payments sooner.
If your interest rate or down payment won’t change much, it is important to make a start. The money you spend on rent could go towards your mortgage payment and the time you spend locked into a rental agreement could be used to reduce your mortgage term.
A mortgage, therefore, is a good investment because everyone needs somewhere to live and it’s better to live in a house that’s improving your net worth than a house that’s improving someone else’s net worth.
Good Investment Returns
Real estate is one of the safest investments you can make. It increases by between 3% and 6% a year on average, but there’s more to it than that. With real estate, you have something solid, stable; it will still be here in ten or twenty years from now and in the unlikely event that it’s not and you lose your asset, you’ll likely have an insurance windfall to cover you.
In that sense, it’s like a high-yield savings account, because your money is safe, you can leave it to grow and appreciate on its own, and if anything happens, you’re insured.
Dividends and Rapid Growth
Real estate offers the best of all worlds, with the stability of savings accounts and the guaranteed profit of bonds. But there’s more to it than that. Like stocks, it’s possible to earn a steady, short-term income in addition to the higher return offered by the long-term investment.
If you rent out your home or acquire a lodger, that valuable investment can start earning you a few hundred dollars a month, all while the actual investment sits and grows. What’s more, if you make a few home improvements (many of which are tax-deductible) you can instantly improve its value.
Home Equity Loans
The more of the house you own, the more equity you can use as collateral. Home equity loans and home equity lines of credit are some of the best loans you can get. They are levied against your equity, which means the lender can afford to offer you a better interest rate, thus reducing your payment obligations and giving you a low-cost, high-balance loan.
We would never recommend paying off your mortgage just so you can get an equity loan. It seems a little counterproductive. However, it’s a great option to have and means that if you ever need a loan in the future, you can get one at a fraction of the usual cost.
Why can a Mortgage be a Bad Investment?
As impressive as all of the above sounds, a mortgage is still a high-interest loan. If you borrow $200,000 over 30-years at a 5% interest rate, you’ll pay close to $400,000 over the term. In other words, it’s a great investment if you focus on the original cost, but that’s not what you’re paying, or rather it’s not what the majority of borrowers are paying.
Assuming the house doubles in value in 20 years, which is a fair (albeit hopeful) assumption to make, that could mean it’s now worth what you paid for it. This is something that many buyers overlook. They focus on the original purchase price, pat themselves on the back when it eventually sells for a 50% profit or more, and fail to consider that they may have actually lost money on the deal.
And then you have the maintenance and upkeep to consider, which the average seller tends to forget about when selling their house for what they think is a profit after living in it for several decades.
Why is the Stock Market a Good Investment?
Between 1900 and 2000, US stocks earned an average of 10% a year based on data from the biggest indexes. Of course, there were some big boom times during this period, but it’s also a period that included two World Wars and a Great Depression. Every time it gets knocked down, it bounces right back up again—it’s the Rocky Balboa of investing.
Thanks to the internet, it is now easier than ever to invest in the stock market. You don’t need a stockbroker. You don’t need to spend several days buying paper stocks and then making eleventh-hour phone calls when you’re trying to sell. Everything can be done instantly online.
You don’t even need a financial advisor, as you can find all the info you need on the internet!
Why can the Stock Market be a Bad Investment?
The stock market doesn’t offer a guaranteed return. As impressive as the above stats are, they are taken from many companies across a very long time. If you put all of your money into a single stock (always a bad idea) there’s a chance the company could go bust, in which case you’ve just lost your money.
In the grand scheme of things, this won’t impact the stock market much and it will bounce back quickly, but you will have lost everything.
Stock market profits are also subject to income tax, with the exact tax rate you pay dependent entirely on your tax bracket. The same is true for most investments, of course, but there are numerous tax benefits when it comes to buying, upgrading, and selling your own house and the same simply isn’t true for stock.
Which Option is Better?
The best option will depend entirely on your financial situation, credit report, stock market knowledge, financial goals, and more, all of which we have outlined in detail below.
1. Your Financial Goals
What is your main financial goal? Do you just want an easy life, at the end of which you can leave money and assets to your children? If so, your mortgage should be your main priority.
Not only will owning your home increase your options and net worth, but it can also be passed onto your children completely obligation-free.
If your goal is to get rich, become a successful trader or investor and/or retire early, it may be a better idea to invest in stocks.
2. Your Equity
A high fixed-rate mortgage, a low-down payment and no extra payments made on your principal can make a mortgage a very poor investment. As discussed already, if you’re paying a high-interest rate over a long term, you may struggle to turn a profit even if you eventually sell the house for 50% more than you bought it for.
However, the sooner you purchase the house and the faster you acquire equity, the more of a viable option this will become.
Let’s return to an example quoted above, of a 30-year, 5%, $200,000 mortgage. This will cost you a total of $386.513 in interest over the term. However, if you reduce the term to 20-years, increase your down payment by $20,000, and get an interest rate that is just 1% lower, you’ll spend just $261,784 over the term, thus improving your chances of turning a profit.
3. Your Debt
The average consumer has at least $5,500 worth of credit card debt and once you factor student loans, car loans, and other debts into the equation, that climbs as high as $40,000, and that’s before we even consider mortgages!
These debts all compound interest, which means you pay interest on interest and get trapped in a cycle of persistent debt. Focusing on clearing your mortgage or investing in stocks when you have mounting credit card debt is like trying to snuff out a match as your house burns down around you.
A $5,000 credit card debt could cost you $1,000 in annual interest payments if you only focus on making the minimum payments, while a payday loan will cost you much more.
There isn’t a single novice investor on the planet who can make a guaranteed profit of $1,000 from an investment of just $5,000 in a single year, so what’s the point of using your money to earn a few bucks when it could save you a few thousand?
Clear your debts before you go any further, focusing first on the one with the higher interest rate and then working your way down the list until you are completely debt-free.
4. Personal Finance Issues
Stock trading is relatively safe if you know what you’re doing and don’t sink all your money into high-risk penny stocks. But this is not the best option for impulsive risk-takers who have had issues in the past.
If you have struggled to invest, save and generally hold onto money, or you have had issues with gambling and excessive spending, the stock market could be a slippery slope. Getting involved before you own any sizeable assets could lead to costly mistakes that eventually end with you losing everything.
Speak with a financial advisor, practice some financial planning, and try to change your ways before you think about investing. Alternatively, just put your money into making extra mortgage payments and clearing that balance as soon as you can.
Invest or Pay Off Mortgage?
Taking all of the above into account, and assuming that you’re an average consumer without a great deal of debt or other issues, you should consider the following:
- Meet Mortgage Payments: It doesn’t matter which option you choose, it’s crucial that you meet your mortgage payments every month as failure to do so could cripple you financially and no amount of high yield stocks will help you recover from that.
- Extra Cash Priority 1: Any extra money that you have should first go toward building a small emergency fund. This will protect you in the event that you can’t meet your monthly payments. It will also provide some peace of mind.
- Extra Cash Priority 2: Assuming you don’t have any high-interest debts, additional funds should be used to increase your monthly mortgage payments, thus reducing compounded interest and allowing you to repay your mortgage sooner.
- Extra Cash Priority 3: Finally, any extra money you have leftover can go towards investments, including retirement savings, stock, bonds, and savings accounts.
- Focus on Good Debt: Avoid acquiring bad debt at all costs and make sure all debt you get is good debt, which is anything that increases your net worth.
- Be Patient: Profiting from long-term investments requires a lot of smart financial decisions and a great deal of patience. Don’t assume you’ll be rich or will clear your balance overnight, because you won’t.
How to Invest in Stocks
If your knowledge of stocks stems from watching films about hectic stock exchanges and drug-fueled traders, you may assume that investing in stocks requires you to wear a suit, shout at strangers, drink whiskey at 8 am and break several financial laws by lunch. In actual fact, it can all be done from the comfort of your own home.
Sign up for a brokerage account by providing basic details such as your Social Security Number and bank account, and use this account to invest in US stock markets. You will pay a commission for every stock that you invest in, but this should be the only cost and you’ll have the entire mercy of the New York Stock Exchange at your fingertips!
Here are some tips to help you get started.
Avoid Penny Stocks and Day Trading
We’ve all heard stories of traders who invested their savings and lost it all. The majority of these invested in penny stocks or did something called day trading.
Penny stocks are cheap and highly volatile stocks. They are small companies that could rapidly increase or decrease in value. If you invest $1,000 in stocks that cost $0.10 each, you’ll have 10,000 stocks. Should they increase to $10 each, which is not unheard of, then you’ll have $100,000 and can cash in.
The problem is, those stocks could just as easily drop to $0.01 or disappear completely, in which case you’ve lost every penny. As for day trading, this amounts to little more than gambling. It involves investing large sums of money in stocks and commodities with a view to selling minutes or hours later, thus profiting from sharp rises and falls.
Stick with Bluechip Stocks
A bluechip company is a large, reliable, established company that trades on one of the main indexes. These are the big boys, the Apple, Alphabet (Google), and Microsofts of the world. They don’t experience the same sharp rises and falls found with penny stocks, but they generally increase steadily over time.
What’s more, they pay dividends, which is essentially an interest payment made to all investors, allowing you to secure between 2% and 5% on your investment every year.
Bide Your Time
When the dot com bubble burst, Amazon and other tech stocks went from being highly sought after and incredibly valuable to being worth next to nothing. Everything crashed, everyone sold up, and it seemed like the end was nigh.
However, not only did Amazon and many other companies recover, but they soon climbed even higher than they were at their pre-crash peak.
This doesn’t always happen and sometimes it’s best to get out while you can, but it proves a point that all investors need to learn: Patience is a virtue.
Novice investors will often spend hours checking their stocks every week, constantly refreshing their stock tickers and getting exciting over every little increase and depressed over every decrease. They’ll cash in a profit when it does well and take a slight loss when it struggles.
But the best thing to do is just be patient, wait, collect the dividends, and bide your time. Providing you’re investing in established companies; they will recover before long.
How to Pay Off Your Mortgage Sooner
If you’ve decided that this is the best option for you and believe that your mortgage interest rate is acceptable, your retirement accounts are sufficiently loaded, and you have an emergency fund, then it’s time to pay off your mortgage, Here are some tips to help you do that.
Wait Until You’re in a Strong Financial Situation
It’s best to wait until you’re in a strong position financially before you buy a house. As alluded to above, a slight improvement in APR, down payment and length could half the amount of interest you pay over the term.
Many buyers rush this process, which is why over 6 out of 10 homeowners have regrets, with many of those regrets concerning their down payment. By waiting until you have more cash flow and a better credit score, you could make the next few decades much easier and pay off your mortgage in no time.
Pay More Than the Minimum
As mentioned above, if you have a 30-year mortgage, 70% of your first monthly payments could be going towards the interest. That leaves just 30% for the principal, which means you’ll make very little headway on your mortgage until a few years have passed.
However, once you have paid the interest for that month, everything else you pay will go towards the principal and thus help you to clear the balance quickly. If your monthly mortgage payment is $1,000, that means paying just $300 more could double your principal payment and shave years off your term and tens of thousands off your total.
Refinancing won’t work for everyone. For one thing, your financial situation will need to have improved for a lender to even consider it. But if it has improved you may be offered an improved contract, albeit usually with a catch, such as an increased term.
We recommend looking into refinance options as soon as your situation has improved, seeing if there are any options available that will reduce your obligations.
Lottery winds, inheritances, tax rebates—the average adult comes into lots of little unexpected windfalls over their lifetime and for many, this money is wasted on vacations, clothes, and other expenses.
Instead of throwing good money away at something that won’t improve your financial situation, put it towards your house instead.
It’s not just about reducing the term. When you pay a lump sum like that, you’ll also reduce the balance, which means you’ll have less interest to pay. Alternatively, you can renegotiate a shorter term with an increased monthly payment, spreading that windfall out over several years to get the best bang for your buck.