Should I pay off the mortgage instead of investing?

 

Should I pay off the house instead of investing?
This is a question I received from a friend recently.
I am already done with paying off my mortgage. I did pay it off but at the same time I did invest too. I only made $1,500 additional principal payments per month.


There are many arguments out there supporting investing instead of paying additional principal to the mortgage. The main argument is that the investments will generate higher returns than paying off mortgage.



Investments will provide gains.
Paying off mortgage will reduce your debt.
What will be better at the end?


Below I will make calculations on my own example.


Mortgage on a $210,000 house

Down payment 20% equals $23,898
The financed amount is $186,102
Monthly payment: $867
The interest rate: 4.37%
The total interest to be paid to lender on a 30 years term: $148,301
Total interest paid in 8 years (paid down the mortgage in 8 years instead of 30): $33,659
Mortgage interest saved: $114,542

By paying off the house early I saved $114,542.

The total extra payments to the principal totaled to $135,000 for the period of 8 years.

The extra principal payments of $135,000 were not available for investing. If I would have invested that money gradually during those 8 years, then according to the bankrate calculator it would have produced $172,157 at the end of those 8 years assuming stable growth rate of 7% per year, 2.9% inflation, 36% federal tax and 0% state tax (for TN). Investing would have produced $37,157more in those 8 years.

Now after paying off the house in 8 years and saving 22 years of paying interest (total mortgage term of 30 years) I can invest the available $1,500 for the next 22 years. That would produce $665,212 with the same 7% returns. 

$665,121-$37,157=$627,964 that is after subtracting the $37,157 I had less by choosing to pay off the mortgage instead of investing for the first 8 years.
But I still paid mortgage interest for 8 years. Subtracting that interest of $33,659 leads to $594,305.


If I would have kept the mortgage for 30 years, and would have $1,500 available to invest from the beginning and until the end of the 30 years period, that would have produced $1,116,708. 
From that I have to subtract the total interest paid for 30 years - $148,301 and that equals to $968,407. 

If my calculations are correct, in 30 years, by paying off the house early and continuing investing $1,500 for the reminder of the mortgage term, I will have only $594,305 instead of $968,407. 
The difference of $374,102 is significant.
This money would have been available in year 2039 (in 21 years).
With the inflation of 2.9% per year that sum of money will equal $205,242 in todays dollars.  

Was it bad for me to pay off the mortgage early and forgo on $374,102 in 21 years?

That is the price I paid for the piece of mind.  I didn't know that, I only found it out today after calculating everything. It surprised me a little. Well, I hope that number will not matter that much when I get to the retirement. 

Those calculations are made for 4.37% mortgage interest. If your interest is lower, it will make even less sense to pay it off early.
All values are calculated with bankrate calculator assuming 7% yearly returns, 2.9% inflation, 36% federal tax and 0% state tax (for TN).


Now I will redo all calculations with more conservative 5% yearly return on investments.
Below is the same text but with different numbers.



The extra principal payments of $135,000 were not available for investing. If I would have invested that money gradually during those 8 years, then according to the bank rate calculator it would have produced $163,553 at the end of those 8 years assuming stable growth rate of 5% per year, 2.9% inflation, 36% federal tax and 0% state tax (for TN). Investing would have produced $28,553 more in those 8 years.
 
Now after paying off the house in 8 years and saving 22 years of paying interest (total mortgage term of 30 years) I can invest the available $1,500 for the next 22 years. That would produce $570,502 with the 5% returns. 
 
$570,502-$28,553=$541,949 that is after subtracting the $28,553 I had less by choosing to pay off the mortgage instead of investing for the first 8 years.
But I still paid mortgage interest for 8 years. Subtracting that interest of $33,659 leads to $508,290.
 
 
If I would have kept the mortgage for 30 years, and would have $1,500 available to invest from the beginning and until the end of the 30 years period, that would have produced $897,551. 
From that I have to subtract the total interest paid for 30 years - $148,301 and that equals to $749,250.   
If my calculations are correct, in 30 years, by paying off the house early and continuing investing $1,500 for the reminder of the mortgage term, I will have only $508,290  instead of $749,250. 
The difference of $240,960 is significant.
This money would have been available in year 2039 (in 21 years). With the inflation of 2.9% per year that sum of money will equal $132,197 in todays dollars.


There are many variables but it appears that you have to go below 3% of yearly returns on investments to break even (the difference at 3% of returns will still be $141,912 before inflation and $77,856 after inflation).



The common arguments supporting paying off the mortgage early are:

1. If you loose the job, you don't need to worry about the mortgage.
2. If you will have to move, you don't need to worry about two mortgages.
3. If you decide to retire early or have to stop working for some other reason, mortgage doesn't need to be covered by savings.
4. It is a way to diversify your investments.

I gather it is a form of diversification of assets and a sort of  insurance for the hard times. It turns out to be quite expensive. If you are thinking about paying off the mortgage early, make your own calculations.