Last week I spoke with 2 different clients who had the exact same question for me.
“Should we pay off our mortgage early or pay the minimum and invest?”
The easy answer and the one you would think an “investment guy” would give, is to always invest. Mortgage rates are still below 4% and the average return of the S&P 500 is close to 10%. Clearly, there is a 6% advantage by investing. But digging deeper and understanding the client’s actual situation, my answers were very different.Client #1 wants to retire in 15 years at the age of 65. The client recently signed a 30-year mortgage (27 years left) at an interest rate of 3.5%. My client has a good job, except the employer doesn’t offer any type of retirement package. This person gets regular raises and has been employed at the same job for almost 10 years, but may be required to relocate in the next 5 years. The client could use current pay and be mortgage free in 15 years, just in time for retirement. Unfortunately, there would be nothing saved for retirement. This client considers his/her self to be an aggressive investor.
This one is simple. Paying off the mortgage in 15 years has them debt free, but no savings or retirement other than social security. This is a dangerous proposition. The math alone easily points to paying the minimum and investing the rest. With 15 years to retirement, you can still build up a nice nest egg, have a home that is mostly paid off, and have the ability to make choices. Also, the chance of having to relocate within 5 years adds another wrinkle, which would make paying the minimum even more advantageous should they have to sell their home and are forced to take what the market is willing to pay.
Should the circumstances be different and they don’t have to move, at retirement they could sell the home and take the proceeds after the mortgage is paid down and invest more, or they could take the proceeds and downsize or rent. On the other hand, if the real estate market isn’t ideal for selling, they can use their built-up retirement and savings to stay in the home.
Client #2 is actually a couple and they were much younger - both early 40’s with 25 years left to work. They both have 401(k)’s through their employers and receive a match to their contributions. They refinanced their house 10 years ago and have been paying it down very aggressively. If they continue with their current trajectory, they will have the house paid off in 5 years. If they go back to paying the minimum, it will take 17 years before the mortgage is paid down. They consider themselves moderately aggressive investors, but hate debt. The idea of being debt free is their main goal.
Again, the math works out for them to pay the minimum amount on their mortgage and invest the rest. But the main goal of this couple is to be debt free. Math is one thing, but achieving your life goal is on another whole level. Also, the math between the two options is very close - within a few thousand dollars based on variables such as the average return of the stock market. Does anyone know what the stock market will do over the next 10 years? I assume it will be higher, but what if it only goes up 6% per year on average instead of the historical average of 10%?
Considering this couple still has 20 years of working after their mortgage is paid off and they each have retirement accounts in place, they will have plenty of years to invest the money they once paid to their mortgage as well as the extra money they were putting towards it. With 20 years and such an aggressive saving and investing plan, this couple will have built up a very nice retirement with no debt.
Even though these clients had the same question, the answer won’t always be the same. By listening and understanding the needs and goals of my clients and looking beyond the obvious, I am able to provide them with the answers they are wanting. There is no such thing as a perfectly laid out retirement plan, but as an advisor, I try to help clients avoid major pitfalls as well as provide them with numerous options.
What's your nagging question? Email me at firstname.lastname@example.org and I will answer it for you.
Note: I can really only answer financial questions....I don't know why your wife yells at you so much and I don't know why your husband is so stupid.