This is a question we see posted all the time, and honestly, it seems like people are more divided on this issue than they are politics (so much so that Dave Ramsey even has a calculator to convince you!). Today, we plan on ending the mortgage vs. investing debate once and for all. AJ has covered this topic in the past, so if you’d like a precursor to this argument, check out the video below.
The dilemma of mortgage vs. investing
You have a mortgage on your house. For each month you carry the mortgage you pay interest to the bank at the agreed upon rate. This interest is payment for the bank providing the loan for you to buy your house. Pretty simple.
You may also have spare cash each month. This spare cash can be applied to your mortgage, speeding up the pace at which it’s paid off. You can also use this cash to invest. The two outcomes are grossly different.
The dilemma: which method nets the biggest gain and puts you on the path to financial independence sooner? Read on to find out…
Mortgage vs. investing math
As an example, we’re going to compare someone with a $100k mortgage and $100k cash in their savings account. The issue is simple: they’re conflicted on the best use of their cash. The problem is that no one seems to want to do the math to figure out the best result. Instead, everybody uses emotion to try and justify their course of action. Let’s get down to the numbers!
Scene setter: You have a 30 year mortgage for $100k with a 4% interest rate. You are conflicted and need to know what to do with the $100k cash in your savings account.
In scenario 1, where you payoff the mortgage, you’d spend $100k in cash and immediately be mortgage debt free. After investing the $477 mortgage payment savings over 360 months at an average return of 10.6% (S&P 500 historical average) you’d have $1,055,296.
For scenario 2, you’d keep the mortgage and invest the $100k. This would cost you $71,720 in interest over 30 years. You wouldn’t have anything leftover monthly, so no more investing. The $100k invested would grow into $2,054,252 after 30 years. We would now deduct the $71k in interest which leaves us with $1,983,252, or a net gain of $927,956 over scenario 1. Yes, that’s right, you gained $927k by not paying off your mortgage.
Now, as much as I’d like to tell you it gets better, it doesn’t. Most people have mortgages way bigger than $100k. Heck, let’s try a $300k mortgage and savings. Scenario 1 would now conclude with $3,168,101. Scenario 2 would net $5,947,237 for a gain of $2.78MM over scenario 1. So keeping that $300k mortgage would make you $2.78MM more wealthy.
Is it really this simple?
Crazy enough, this is one of those things that people on both sides of the argument think are really simple, however, one of them is wrong! Unless you’re carrying a mortgage of 6 or 7% or more, this isn’t even close. The only benefit of paying of a mortgage early is the euphoria of being “debt free” or “financially independent”. But don’t forget, you’ll still owe property taxes and want to protect yourself with homeowners insurance. This is a loser all around.
I get it, I’m not covering ALL scenarios. Maybe you can take a happy middle-ground approach where you put half of your cash toward the mortgage and invest the rest? Nope, still sucks. Instead, this is a way to try and appeal to both sides of your emotions, which often fails as well. Why not just invest and keep making a mortgage payment? In 30 years, you’ll have no mortgage and a pile of cash!
Where to start your investing journey
For some of our readers, this conversation may be irrelevant because you haven’t saved $100k. Well, everyone starts somewhere. Take $100 a month and start investing in an index fund such as VTI or VOO. If you get a pay raise in 2024, increase that amount by your pay raise. Pretty soon you’ll be saving some serious loot. Oh, and don’t forget to keep reading/watching us at the Wealthy Idiots!
