Pre­pay mort­gage or in­vest

The Covington News - - Business -

If you’re for­tu­nate enough to have some dis­pos­able in­come ly­ing around, you might want to use it to ad­vance your longterm fi­nan­cial goals. If so, you can choose among many dif­fer­ent op­tions. Here’s one such de­ci­sion: Should you make ex­tra prin­ci­pal-only mort­gage pay­ments, or should you in­vest the money?

There may not be a clear-cut an­swer to this ques­tion, be­cause each choice — to pre­pay or in­vest — has some mer­its. So be­fore mak­ing any de­ci­sions, you’ll need to fa­mil­iar­ize your­self with both op­tions.

To be­gin with, you might try to cal­cu­late whether pre­pay­ing or in­vest­ing gives you the great­est fi­nan­cial re­turn. To come out ahead by in­vest­ing, you’d need to find an in­vest­ment ve­hi­cle that paid more than your fixed mort­gage rate. For ex­am­ple, if you pay off a fixe­drate mort­gage of 5 per­cent, you are in ef­fect “earn­ing” a 5 per­cent re­turn, so if you found an in­vest­ment that paid 6 per­cent or 7 per­cent an­nu­ally, you could say that you’d be bet­ter off mak­ing the in­vest­ment rather than pre­pay­ing your mort­gage.

At first glance, you might think your choice is clear. Af­ter all, you rea­son, it shouldn’t be too hard to find an in­vest­ment that pays 6 per­cent or 7 per­cent. Over the past 80 years, large­com­pany stocks have re­turned on av­er­age more than 10 per­cent an­nu­ally, ac­cord­ing to Ibbotson As­so­ci­ates, a lead­ing in­vest­ment re­search firm.

And yet, de­spite th­ese fig­ures, you can’t nec­es­sar­ily con­clude that in­vest­ing al­ways beats pre­pay­ing. For one thing, as you’ve no doubt heard, “past per­for­mance does not guar­an­tee fu­ture re­sults.” And those im­pres­sive long-term stock mar­ket re­turns are just aver­ages; though the mar­ket has trended up­ward over the long term, it can also go through ex­tended pe­ri­ods of low re­turns, or even siz­able losses. But when you pay down your mort­gage bal­ance each year, you’re earn­ing a reg­u­lar, low-risk “re­turn” in the form of in­ter­est sav­ings. So you need to ask your­self if you can ac­cept tak­ing on greater in­vest­ment risk in ex­change for a po­ten­tially higher re­turn.

Fur­ther­more, you might find it psy­cho­log­i­cally ben­e­fi­cial to pay off your mort­gage as soon as pos­si­ble. And the less you owe on your house, the greater your profit when you sell it.

But other fac­tors may weigh against pre­pay­ment. You gen­er­ally get a tax de­duc­tion on your mort­gage in­ter­est, and this de­duc­tion, es­pe­cially in the early years of your mort­gage, can be con­sid­er­able. Even more im­por­tantly, though, is the need to di­ver­sify. If you have all your money tied up in your house, and the hous­ing mar­ket slumps, as it has re­cently, your net worth might suf­fer more than if you had spread your money around a va­ri­ety of as­sets, in­clud­ing stocks, bonds and gov­ern­ment se­cu­ri­ties. (Keep in mind, though, that di­ver­si­fi­ca­tion by it­self can­not guar­an­tee a profit or pro­tect against loss.)

Clearly, you’ll need to weigh all th­ese fac­tors be­fore de­cid­ing whether to pre­pay your mort­gage or in­vest. For­tu­nately, it’s not al­ways an “ei­ther-or” ques­tion. One month you could pay more on your mort­gage while the next month you could in­vest any money you have avail­able. It’s your choice — so make the most of it.

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