Owning a home outright is a dream that many Americans share. Having a mortgage can be a huge burden, and paying it off may be the first item on your financial to-do list. Competing with this desire to own your home free and clear is your need to invest for retirement, your child’s college education, or some other goal. Putting extra cash toward one of these goals may mean sacrificing another. So how do you choose?
Deciding between prepaying your mortgage and investing your extra cash isn’t easy, because each option has advantages and disadvantages, but you can start by weighing what you’ll gain financially by choosing one option against what you’ll give up. In economic terms, this is known as evaluating the opportunity cost.
For example, the after-tax cost of a 4.75 percent mortgage would be approximately 3.25 percent if you were in a combined federal/South Carolina tax bracket of 32 percent and qualified to deduct mortgage interest on your return. Could you receive a higher after-tax rate of return if you invested your money instead of prepaying your mortgage?
Keep in mind that the rate of return you’ll receive is directly related to the investments you choose. Investments with the potential for higher returns may expose you to more risk, so take this into account when making your decision.
If you need to invest for an important goal, but you also want the satisfaction of paying down your mortgage, there’s no reason you can’t do both. It’s as simple as allocating part of your available cash toward one goal, and putting the rest toward the other. Even small adjustments can make a difference. For example, you could potentially shave years off your mortgage by consistently making biweekly, instead of monthly, mortgage payments, or by putting any year-end bonuses or tax refunds toward your mortgage principal.
Remember, no matter what you decide now, you can always reprioritize your goals later to keep up with changes to your circumstances, market conditions and interest rates.
Life is a journey; plan for it.