Should You Pay on Your Mortgage or Invest Extra Money?
Every Monday, we address one of your pressing personal finance questions by seeking advice from several financial experts. If you have a general question or money issue, or just want to talk about something PeFi-related, leave it in the comments or email me at [email protected].
This week, the question comes from Ethan:
I’m going to inherit some money. I am 45, I have a wife and two children. This money is not enough to retire, but it is enough to change your life. For example, I was able to pay off my student loans.
I will have enough money to pay off my mortgage, but I’m not sure if I should. If I do this, it will not destroy my inheritance, but it will be a large part of the inheritance. My instinct tells me to think of my mortgage as a 4.1% loan and decide if I can do better with index funds. But I don’t know if there are other considerations to think about, because mortgages are weird.
This is what individual experts usually say about a problem that affects each person differently: if you need personalized advice, you should see a financial planner.
Remember interest rates
What a problem! First things first: do you have a sufficiently secured emergency fund, have you paid off your credit card debt, and have your pension contributions been depleted? If not, do it first. If you do that, then things will get interesting.
Basically, all the experts I spoke to said the same thing: Don’t pay your mortgage. If it is fixed at 4.1 percent, you are more likely to get a better return on other investments. (Just think about the cost of inflation on the products you use every day.)
And there is something else that you are missing. “For example, if a reader deducts interest on a mortgage from their taxes, their effective interest rate will be below 4.1 percent,” says Parker Trasborg, a certified financial planner in Virginia. So if you, for example, belong to the 24 percent tax category, then the true cost of the loan is 3.11 percent on Trasborg, making it even less urgent to focus on paying back. “We may never see mortgage rates so low in our lives again,” says Ashley Foster, a financial planner based in Texas.
You don’t want to pay low interest mortgages and give up potentially higher incomes. According to Vanguard , the portfolio was 70 percent stocks and 30 percent of the bonds generated an average 9.1 percent annual return from 1926 to 2016. While there is no guarantee that this trend will continue, you are more likely to make more profit if you invest your inheritance in low-cost index funds.
“Index funds tend to be more tax efficient because there is less tax burden, so investing money from a mathematical point of view is probably the best option,” says Karl Golubovich, a certified financial planner based in Washington. “Investing money also gives you more liquidity, which means you can easily sell and access cash if needed. If you pay off your mortgage, most of your home equity will be tied to your home equity, and in order to get it, you will either have to sell the house or take out a loan. ” If you do decide to invest, your allocation should be quite aggressive given your age.
However, it depends on your priorities. “I tell people that the math is irrefutable, that having a long-term fixed mortgage makes economic sense, but spreadsheets shouldn’t sleep at night,” says John Scherer, a certified financial planner in Wisconsin. “The goal of smart money management is to achieve financial peace of mind, not be left with the biggest pile of money. So if the worst decision anyone makes is to pay off their mortgage … but it helps them sleep at night, they should. “
But there may be a golden mean. Kathleen Campbell, a registered investment advisor in Fort Meyers, Florida, suggests talking to your lender about paying off a portion of your mortgage, which will allow you to “ re-amortize ” the balance if it’s a significant chunk. This will reduce your monthly payments in the future.
“For example, if their original mortgage was $ 300,000, then their payments are based on a principal of $ 300,000,” Campbell says. “But if they pay out $ 100,000 and their new balance is $ 200,000 or less, then when they are re-amortized, that amount will be used as principal and the new payments will be much less.”
However, there is no guarantee that this will work. Here are a few more options.
Some alternatives
You may also consider adding some money to your kids’ college funds if you plan on helping them pay for their tuition. “He mentions that he has two children, so my first recommendation is to put some of the money into a good 529 plan,” Campbell says. “Depending on the state they live in, their state may even provide state tax breaks for 529 plan contributions. If the state does not have tax breaks, they should find the best and least expensive plan. ”
You can find a list of the best and worst plans here . Campbell singles out the Utah Education Savings Plan (called the “My 529” plan) as outstanding.
And you can always maximize your contribution to your company’s retirement plan by using inheritance money to offset cash flow and maximize IRA contributions for you and your spouse.
Craig Coles, a certified financial planner from Texas, says money is king. There may come a time when you have tax or unexpected medical bills. “They can easily save you $ 10,000 for a one-time event,” says Coles. So, of course, it is important that some of the liquid remains liquid.
One more thing: combining your inheritance with assets that you and your spouse own could put you at risk of losing it in the event of a divorce, or if your spouse once makes a civil decision against them, depending on the state. “You can also talk to an estate planning attorney about how to protect this money,” says Brad Wright, a certified financial planner in Massachusetts. Just in case.