Category: Fixed income investments

Why paying off your mortgage early might be a bad idea

As a financial advisor, I have many clients ask me if they should use extra money to pay down their mortgage or invest the money. Let’s take a closer look, my savvy LGBT friends, at the math to see what makes sense.

The following is a hypothetical, purely for demonstrative purposes:

If you have a $250,000 fixed rate, 30 year mortgage at 4.25% interest, your total amount that you will pay over 30 years will be $456,018.
If you add $200 a month to your payment to be used towards the principal, you will pay off the mortgage in 23 years. Your total amount that you have paid will be $399,455.
Pretty good, right? You’ve saved yourself $56,563 in interest payments. That’s some real money!

What happens if instead, you invest the $200 a month in a tax free vehicle, such as a ROTH IRA?
For this hypothetical, we are investing $200 a month, over the course of 23 years (the amount of time we would be paying extra on our mortgage) with a 7% annual return on your investment. Keep in mind, this isn’t picking or recommending a specific investment, this is a hypothetical return. Whew.

So… $200 a month/23 years/ 7% annual return will get you: $133,059.

Holy cow! That’s quite a bit of money. Much more than the $56,563 that you would save if you were to pay more on your mortgage.

In this situation, where you invest the money, you are $76,496 richer!

This difference is even greater if you take into consideration the interest rate tax deduction you get every year. When you file your taxes, you have a line that allows you to enter how much you’ve paid in real estate mortgage interest.

Part of the amount that you pay in mortgage interest gets deducted from your taxes on your return. In effect, because you may potentially lower your taxes because of this deduction, your real out of pocket costs on borrowing that money isn’t the 4.25% on our hypothetical loan. It can be less than that. It depends on a myriad of factors, such as your income, etc. However, lets’ assume for a hypothetical, that your REAL cost to borrow money after your tax deduction is only 3%…
$250,000 mortgage/3% interest/extra $200 month – You still pay off the mortgage in 23 years, but you only save $32,927 in interest. This widens the gap between paying down the mortgage/investing even more!
The invested money will get you $133,059. The mortgage pay down will save you $32,927. That’s $100,132 more in YOUR pocket after 23 years.
I don’t know about you, but I’d rather have the $100,132 extra.

Disclaimer time: These are hypotheticals. Tax deduction is a hypothetical amount. ROTH IRA’s are something to discuss with a financial advisor to see if they are a good fit for your needs. You get my drift. We are playing with numbers. Also, this information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Want to play with some numbers yourself? Check out these financial calculators
As always, speak to a financial advisor about the best course for you to take.
Sharon L. Herman AAMS, ADPA is the CEO of Silver Key Wealth Management
The opinions expressed in this material do not necessarily reflect the views of LPL Financial.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Independent Financial Partners. IFP is a registered investment advisor. IFP and Silver Key Wealth Management are separate entities from LPL financial.
Ms. Herman may only discuss and/or conduct transact securities business with residents of FL, MI, GA, NJ, VA, TX.