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Pay down mortgage or invest?

November 6th, 2015 at 10:26 am

Does it makes sense to pay down your mortgage or invest? For the most part it depends. Depends on your risk tolerance. Depends on your age. Depends on if you bought too much house. But honestly the numbers support investing first, especially in tax deferred (401k) or tax free (Roth IRA) accounts before you pay a penny in overage to your mortgage. The big reason being you can't go back and put the money from your mortgage being paid off into past years contributions.

What do the numbers say? I use round numbers because it's easier. Assume a couple with a stay at home mom, 2 kids, and an income of $100k and are 35 years old. Assuming Couple A contributes 15% to their retirement and the rest of their money to their mortgage. Couple B maximizes the retirement savings to 401k+Roth IRA and nothing to their home. They have a mortgage for $300k on a home worth $360k.

What ends up happening?

Couple A
$15k retirement/year, pays home in 15 years because they have an extra $10,500/year for mortgage paydown. They then divert $1551/month into retirement/taxable savings for the next 5, 10, 15 years.

Couple B
Saves $29k/year and pays less in federal income taxes. But they don't pay down the mortgage because all their extra money goes to retirements savings.

Couple A - using a 6% Return on Investment (ROI)
15 years retirement $358,462.00
20 years retirement $566,801.00
5 years tax/retirement $107,773.00
25 years retirement $845,365.00
10 years tax/retirement $251,998.00
30 years retirement $1,218,146.00
15 years tax/retirement $445,002.00
Total savings = $1,663,148.00, No Debt

Couple B - using 6% ROI as well
15 years retirement $693,181.00
20 years retirement $1,095,510.00
25 years retirement $1,633,918.00
30 years retirement $2,354,429.00, No Debt

Couple B has $691,281.00 more than Couple A after 30 years and a paid for home as well.

Couple B has been paying less federal taxes because they are using the 401k to lower their taxes. Because of this they actually after getting close a 40% bonus savings rate. How? Well they are saving $29k/year versus $15k/year for Couple A, but Couple A overall only had $10,500 extra to direct to the mortgage for extra savings. So almost a 40% bonus just from less taxable income.

But after 15 years Couple A is debt free. True, but Couple B likely are decent savers having put savings on auto-pilot. And whose to say either couple won't cash out their homes and downsize? In which case Couple B could in theory be debt free as well. But likely not.

2 Responses to “Pay down mortgage or invest?”

  1. Rachael777 Says:

    I appreciate the example. I am questioning this myself.. I can already max out the retirement plans so do I pay down the mortgage (5.375%) or put towards taxable mutual fund investments. My currrent plan is to do a lot of extra savings (taxable funds) and maybe put $500 a month towards extra for the house and any large windfalls go to the house. goal is to have the house at less than $100k by 6/2018. thanks for writing this out. VERY interesting!

  2. Livingalmostlarge Says:

    Paying down the mortgage is a better deal when the interest rate is higher. But it also skews towards paying off if you have maximized tax sheltered accounts. I think depends on age and rest of savings as well. Rachel you have a very aggressive real estate strategy as well for paying off your investment properties. So that should probably be focused before your own house.

    After we buy our next place we'll likely be maximizing retirement and an employee stock purchase plan before paying down the mortgage. But the mortgage will move higher since we should have more disposable income. Of course college costs might mitigate that.

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