Extra Mortgage Payment Or Investment?

A popular question in the personal finance world is whether one should make extra mortgage payments or invest the extra money. The easy answer is to pay off your mortgage as it obviously is a good thing to pay off any outstanding debt.
 
Making additional mortgage payments can result in significant savings for a homeowner. Just by paying one extra payment at the end of each year, you will reduce your 30 year 200,000 mortgage by 5 years. On this same mortgage, given a 5.5% interest rate, you would save $39,500 in mortgage interest. That is pretty significant savings.
 
Even though paying extra on your mortgage is always good, it may not always be the best. There are 3 key questions that should be asked when determining if one should make extra mortgage payments or invest that money. They are:
 
What current rate of return can I receive if I invest the money?
What interest rate am I paying on my mortgage?
What tax savings do I receive each year by deducting my mortgage interest?
 
These 3 questions will help you determine if an extra mortgage payment is right for you. The most basic way to solve this is if your current mortgage rate is higher than what you can get in a fixed account (CD, bond, savings, etc.) then you should use the money to make extra payments on your mortgage. If you can get a CD or other fixed investment at a higher rate than your mortgage, then it makes sense to invest the money and not use it for an extra payment.
 
The other thing you have to consider is your taxes and fees. It would be advisable to determine how much money you save in taxes each year by writing off your mortgage interest. If your tax savings would be somewhat significant, then it might be more beneficial to invest the money and bypass the extra mortgage payment. However, in most situations, using the rate test is going to be the best guide.
 
The only other thing I would mention is that some investment accounts carry fees and will ultimately lower your rate of return. A good example of this would be fixed annuities which carry heavy fees. Also, most non-retirement investment accounts will be taxed which will also lower your true rate of return. So, this is something to keep in mind when determining the actual rate of return on any investment.
 
Every situation is different so each person needs to perform a self examination. It would be very advisable to have a full amortizing loan calculator when making this decision. I have one available for free on my site at http://www.dollarstep.com/loancalc.html. I would recommend using this regularly. You can learn more by going to my website at: http://www.dollarstep.com

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