What a great problem you have – cash flow and savings and you want to know what to do with it…

Is It Better to Pay Off Your Mortgage or Invest?

This article assumes you’ve got some cashflow (more income than expenses) or savings that you are looking to invest. Your options are that you could pay down your mortgage OR take those funds and invest them.

At least as of writing this article, you can expect to average about a 7-8% return on your money if you invested over a long period of time in something like an index mutual fund (or real estate). The opportunity cost is that you could save yourself maybe 3% interest by paying off your mortgage (mortgage rates are at 3% for 30 yr fixed at the time of writing this article). On paper – it seems obvious to go with 8% return over a 3% savings right? If it was purely a financial/investment decision, YES. But it’s not just a financial decision, is it? You have other intangible factors to consider:

• How would your investment philosophy change if you knew your home was 100% owned by you? And the bank couldn’t take it away…
• How would you feel having paid off the house instead of being a slave to the bank for 15 or 30 years?
• How does your significant other feel about owning a home without debt?

From purely a financial standpoint, investing extra cash or savings and earning 8%+ ROI is better than saving 3% in interest on a home mortgage.

Do you like working for the bank?

You work for the bank. Yeah, the one that you owe your mortgage to – that bank makes money on you. Every month, a large chunk of your working life is spent paying the bank your mortgage payment. How many hours is it? There’s a formula for that:

Take your monthly mortgage payment (**Principal + interest + private mortgage insurance if any) and divide that by how much you make per hour at your job.

For example – let’s say you have a mortgage that is $1,500 per month and you make $60,000 salary. Let’s also assume you work 40 hours per week. So you make $5,000/mo (60,000 / 12) and divide $5,000 by 160 = $31.25 per hour. $1,500 mortgage payment divided by $31.25 equals 48. Every month you are a slave to the bank for 48 hours of your working life that month. And next month? You start over again with another 48 hours of your working life a slave to the bank. This applies to any debts you have. Debt is bondage, financial servitude.

You can probably imagine why so many (like Dave Ramsey) advocate for paying your house off as quickly as possible. Do you like working for the bank?

*Note: This exercise is beneficial to do with all of your large expenses (car payments, credit card debt, subscriptions, etc…) Is it worth XX hours every month of work for you to own that thing you continue to pay for?

Understanding Good Debt vs Bad Debt

There may not be such a thing as “good debt” but for the sake of argument, let’s make a clarification between two types of debt – one being better than the other:

• Good debt has low interest rates and good terms.
• Good debt is paid for by others (think rental property with a mortgage that is paid for by a tenant)
• Good debt is debt against an asset that appreciates (increases) in value over time
• Good debt is a tax write-off
• Bad debt has a high interest rate (think credit card debt, etc…)
• Bad debt is against a depreciating asset (value goes down over time)
• All debt is a lien that gives the lender the right to control an asset if you don’t pay the debt.
• All debt means you are a servant to the lender until the debt is paid (unless tenants pay the debt, then technically they are the servants of the lender… until they stop paying and you are on the hook to make the payments)

Avoid debt altogether if you can. Do everything you can to avoid bad debt especially. Pay off bad debt first.

Is There a Way to Do Both – Pay Down Mortgage & Invest?

What if I told you that you could pay your house off quicker and still keep your options open to invest? This requires discipline. It requires a proper financial foundation before you should even consider it. In fact, unless you make significantly more than you spend (you have a high savings rate), I wouldn’t recommend it. The strategy is called Velocity Banking. I’m only going to briefly mention it here – as it deserves its own dedicated post, explanation, warnings, and guidance.

*Important Note – be sure to have the guidance of someone experienced in Velocity Banking before attempting to follow the process.

Basically, you open a HELOC against the equity in your home, use that HELOC to pay off your 1st position mortgage, then throw nearly all your savings, your positive cash flow each month, and cash on hand to pay off that HELOC as quickly as possible. You will save yourself interest charges on the balance owed the more you are able to pay down the debt. You will likely feel more comfortable paying off the HELOC than paying down your 1st mortgage directly because the HELOC is a revolving line that can be pulled out and paid back any number of times (during the draw period – typically 10-15 years in length) and if you need cash for emergencies or short fuse investment opportunities, you can always take out additional money against the line of credit. Again, this is something that must be followed with strict discipline in order to avoid costly mistakes with the execution.

Stay tuned for a future post on Velocity Banking coming soon (including some unique loan products that align well with the strategy).

**A quick note – A portion of your mortgage is principal.   You could exclude that from your calculation as principal payments are retained as equity (but access is through a HELOC, home equity loan, or selling the house). But for the sake of the argument I left principal in there for simplicity.