What a dicey topic, but it is a question that most of us will face during the early stages of our working career. I choose not to. My goal is to maximize the duration of time available for my investments to grow exponentially. Here are a few of my considerations.
- I lock in mortgage rates for 30 years at the best interest rate possible (I am at 2.75%). The prinicpal and interest payment is locked at a flat rate for the duration of the loan. Only the escrow (insurance and property taxes) tend to increase over time due to inflation.
- I absolutely make sure I am contributing at least the minimum in my employer’s retirement plan (401k or 403b for example) to obtain the company’s match. It’s free money! At my current job, they match 50% of my contributions up to 6%. This means if I contribute 6%, my employer will contribute 3%. That is an immediate 50% return on every dollar I invest the minute I invest it. It grows exponentially (historically 10 to 11%).
- I invest in low cost index funds. My favorite is the Vanguard Total Stock Market Index Fund (VTSAX). It has averaged 11% annual returns over the last 30 years and grows exponentially.
- Inflation has averaged 2.12% over the last 30 years. So the buying power of U.S. dollars goes down 2.12% yearly. With my mortgage being 2.75% interest, I can anticipate the actual buying power of the money I pay back to the bank over time is decreasing by almost as much as the interest I am paying. The actual cost of borrowing the money from the bank is very little (0.63% in this example).
- Assuming I have money to invest after I have bought a house and contributed enough to gain my employers retirement account match, I choose to invest in a non retirement brokerage account (Vanguard is my favorite) in the VTSAX index fund as well. I prefer to prepare for the future based on historical performances. VTSAX grows an average of 11% yearly and grows exponentially. My mortgage interest is only 2.75% and is a flat payment. History would dictate my money invested will far outpace interest payments saved by my putting the extra money in VTSAX rather than making extra payments on my mortgage.
- My Vanguard brokerage account is accessible (liquid). If I have an emergency, I can sell however much I need from my account and have the money in my bank’s checking account within a business week. If I had put the money into extra principle payments on my house, that money is not accessible for an emergency.
- If I lost my job, I could use my brokerage account to live off of and make my mortgage payments until I get back on my feet. If I had put all that money into extra principle payments on my mortgage, I am at greater risk of being unable to make my next mortgage payments. It is worth considering that the more equity (home value – principle still owed) I have in my home, the more financial incentive the bank has to foreclose on my house as soon as possible should I start to miss mortgage payments.
- VTSAX averages double digit exponential growth. If all I wanted to do was pay off my mortgage, I would likely be able to do so more efficiently by contributing to the fund allowing it to grow over time and then using it to pay off the remaining mortgage principle once they reach parity (leaving money available to pay any capital gains of the sale of VTSAX investment returns of course). I will never choose that course. I have instead used the non-retirement brokerage account to fund home and rental repairs or to use as a down payment to buy rental properties.
My Own Consideration.
My home mortgage is near $400,000 at 2.75% interest for 30 years.
Let’s assume I have an extra $500 per month to either invest or pay down the mortgage principle.
The extra $500 per month principle payment on my mortgage will result in my house being paid off in 20 years and six months which would save me $64,463.81 in mortgage interest. $500 per month extra paid over 20 years and six months is $123,000 in extra principle payments to save $64,463 in interest over a 20.5 year time duration.
The extra $500 per month invested into the Vanguard Total Stock Market Index fund growing at it’s 30 year average growth rate of 11% would yield a fund value of over $432,000 after 20 years or $489,000 after 21 years. Of course, the returns could be much lower. At a conservative growth rate of 6%, the mutual fund would still have a value of over $231,000 after 20 years and $251,000 at 21 years. Better yet, if we chose an investment that only grew at an average that matched our mortgage interest rate paid of 2.75%, it would be worth over $159,000 after 20 years and $170,000 at 21 years.
I do appreciate that my mortgage interest rate is very low. I have had higher mortgage rates on my properties in the past. I have taken advantage of periods of low interest rates to refinance my home which is how I obtained this low rate now.
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