If you have an extra chunk of change, maybe through an inheritance, a salary increase, or winning the lottery, congratulations! Now you have some decisions to make on how you should spend the money. Should you pay off your mortgage or invest the money in the stock market?
Paying off your mortgage can save you on interest.
You might be quick to want to use the extra money to pay off your mortgage. Doing so can relieve you from making monthly mortgage payments and can also save you from paying lots of interest over the years.
For example, if you borrowed $200,000 with a 30-year fixed mortgage at an interest rate of 3.25 percent, your monthly mortgage payment for principal and interest (only) would be $870. If you stay in the home for 30 years, you’ll pay about $113,350 in interest over the years.
That’s a considerable amount of money you can save by paying your mortgage off. But what if you don’t stay in your home for 30 years? Paying your mortgage off might make sense if you plan on staying in the home for longer than the duration of your home loan, whether it’s 15 or 30 years, but you could end up losing money if you pay the mortgage off then move and get less for your home than you paid for it.
You can also save on the interest you pay on your home by increasing the amount you pay on your monthly mortgage payments. For example, if you pay an extra $2,000 on your mortgage each month, your mortgage will be paid off in 6.5 years and you would have only paid about $22,000 in interest. You would save almost $91,400.
Another way to save on the interest you're paying on your mortgage is by refinancing your loan, especially if the interest rate on your mortgage is a point or more above what the current interest rates are. Now more than ever, your debt isn’t costing you much since interest rates are at 3 percent or below.
You can grow your money through investing.
While paying off your mortgage will save you money in interest you would have paid, investing your money in the stock market can actually help you make money. Historically, the stock market has an 8 percent return rate, which is typically higher than mortgage rates.
If you were to invest $2,000 a month for 6.5 years in the stock market at an 8 percent annual return, you would earn about $203,700. That’s a considerable amount more than what you would save by paying off your mortgage.
Investing in the stock market can pose some risks and you could lose money. Usually, the stock market is more volatile than the housing market. The best way to avoid this volatility is to diversify your portfolio into different investments like bonds, stocks, and real estate.
If you're lucky enough to have a little extra cash in your pocket, it’s a good idea to talk with a financial consultant who can walk you through the specific pros and cons of both options.