One of the most frequent questions I see popping up these days is whether or not we should continue to invest in stocks, or pay off our mortgages early? There are many factors driving the urgency behind this question. The down economy, and endless talks of deficit spending, national debt, etc, seem to have awakened people from their personal debt slumber. Folks are finally making serious dents in their personal debt, and I think that is a good thing.
Photo by sacks08
But what about mortgages? Real estate has been a pretty touchy subject as of late. Many people now find themselves underwater – owing more on their mortgage balance than their home is worth. Those not currently in a home have taken a much more cautious approach to home buying than just a couple years ago, when anyone who could scrape up closing costs and had a half-decent FICO score were jumping into jumbo mortgages they could ill-afford.
Now that we have seen real estate is not a sure thing when it comes to appreciation, and that the market can basically go nowhere in an entire decade, we are questioning some long-held assumptions about the world of finance. Maybe it doesn’t make since to keep a mortgage. Maybe paying off a mortgage early, and living debt free, is the ultimate hedge against what the future might hold. Maybe renting isn’t such a bad deal after all.
Using Investment Money to Pay Off Mortgage
I was recently asked by a friend if they should pay off their mortgage using $120k in taxable investment accounts. I asked him the opposite of that question. “If you owned your home free and clear would you take out a mortgage to put $120k in the stock market?” Naturally, he replied, “Of course not!” Same thing.
That question gets right to the heart of the matter: risk. Our society seems to be going through a pull back thanks in large part to the pains we’ve experienced after watching each other go on a credit binge. It goes beyond being frugal. People are downright scared. And for good reason.
Unemployment is still hovering around double digits (real unemployment is much higher). I read a new article every day about the coming bust in commercial real estate. The student loan program appears to be under strain (and might get overhauled along with the healthcare system). And will there be a double dip to this recession? There is a lot of uncertainty out there.
I often advise people to make paying off their mortgage a priority, once other financial goals such as retirement investing and saving for college are in place. However, I’m going to go a step further. I believe, over the next decade, we are going to see some unprecedented shifts in the way our economy operates – some good, some bad.
I think those who are completely debt free will be the most insulated from the negative effects of the changes, and have the most opportunity to be successful. That doesn’t mean you’re doomed if you have a mortgage (at least I hope not, considering I still have one myself), but it does mean that finding a way to pay off your mortgage should be near the top of your financial priorities.
What About the Opportunity Costs Lost By Not Investing in the Market?
Well, assuming market values appreciate in the coming decade, there is a cost to paying off your mortgage rather than investing in stocks. However, if I asked you if you’d rather owe nothing on your home or have $150,000 in savings in ten years, which would you pick?
Not having a mortgage could mean living comfortably on $1,000 a month less (or more, depending on your home loan). With $150,000 in stocks, you are doing pretty good, but certainly no where near financial independence. And you’d still have that big mortgage payment to contend with.
In a perfect world we could do both: pay off the mortgage early and invest in the stock market. Unfortunately, most of us don’t have that many dollars to play with. So, the ideal compromise may be to save for retirement, save for college for your children, and then pay off the mortgage early, rather than invest in taxable investments outside of retirement accounts.
This is the plan I will adopt, with the exception of adding to my dividend stock portfolio over time in an effort to boost passive income.