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“Worm or beetle – drought or tempest – on a farmer’s land may fall,
Each is loaded full o’ ruin, but a mortgage beats ’em all.”
This is one of the most common questions I’ve faced as a planner. It’s a question that we ourselves faced at one time. We had a mortgage on our condo and extra income, and then, when I sold down my shares in the company I co-founded, we had a windfall of extra money coming in.
What to do with the extra money?
Pay down the mortgage or invest it?
There are two schools of thought.
Pay down the mortgage because it’s a known return.
Even if you’re already getting enough itemized deductions outside of the mortgage so that your mortgage interest can be completely deducted from your taxes, you’re still getting (1- your tax rate) * your mortgage rate as a return on your investment. Given how volatile the stock market is, it’s tempting to rest easy at night knowing that you’ll get the mortgage paid off sooner and reduce your expenses going forward.
For those playing along, this is the route that we chose.
Invest in the markets because the average return is higher than the mortgage.
The compound average growth rate of the S&P 500 from 1871 through 2013 is 9.07%. The current average mortgage rate hovers around 4.5%, so you’d be getting double the return, assuming that you got the average growth of the S&P 500 over time.
Of course, averages mean that you’d have ups and downs. You could run into a series of down years such as when the tech bubble burst or the Great Recession. Would you be able to handle the swings in your portfolio if you were making less than your mortgage rate?