Many people get to the point after Baby Step 3 of having a nice sized emergency fund and they wonder what to do next. Should we start investing our extra money, or should we use it to pay off our mortgage. This is where I find myself currently, and I’ve been debating myself back and forth over which is the better plan. Some days I think investing makes more sense, others I think I can’t wait to pay off my mortgage.
Now, I’m not going to pretend to assume I have the right answer for everybody and their situation, but this is what I think is the best idea. I know many will disagree, even the “experts” all have a different idea in regards to this choice. In my opinion, the best thing to do is … drumroll … both. I know that’s cheating and getting around the question, but really think it makes the most sense.
Now, I think the percentage that goes to each is up for debate. Dave Ramsey suggests putting 15% into retirement funds and then putting the rest on the mortgage. I’m not sure I agree, but I think it is reasonable. I think it really depends on the individual situation though. Are you really conservative, and planning really conservative investments? If that is the case I’d probably suggest paying more on the house. Essentially it is a really conservative investment that net’s you the percentage interest you are paying the bank. It is certainly better than putting your money in a CD at this point.
Are you a bit more aggressive, and young, and investing for the long term? If that describes you, as it does me, investing a bit more is probably the best way to go. Over the long term, there is at least a pretty good chance you can do better investing than in the mortgage. Though because of the risk, I certainly wouldn’t advocate putting all of the extra money you have towards investments.
I think a good starting point is to simply take all of your “extra money” and divide it in half. Put 50% towards the house, and put the other 50% in investments. Adjust the percentages as needed based on your current risk tolerances and needs. Also, you need to take into account the current investing environment. Right now interest rates are really low. As such, you may be more likely to invest since it is a low interest rate you are paying. On the other hand, if you are more conservative you might say that there isn’t anything safe paying much at all so you might as well pay off the mortgage. It really just depends on what type of person you are.
On the other hand, there could be a situation in the future where it doesn’t make any sense to pay off the mortgage. Some people refinanced recently for less than 4%. I remember a time when you could get more than that from a savings account or CD. If interest rates rise in the future (which they will, nowhere to go but up from here) then you could be in a situation where you can get a risk free return that is higher than your mortgage rate. In that case I’d suggest putting the money towards the investments.
Now, I personally really want to pay off my house, and I can’t wait for the freedom that will bring. So even in the scenario where I’m making more interest risk free than I’m paying, I might be willing to go ahead and pay off the house. Something about being totally debt free is really enticing. Not owing anybody anything sounds really great, and if you’re like me I won’t fault you for paying off the house when you save up enough to do so.
Conclusion: Do both, because those of you that want more risk need a little bit of the conservative investment that is paying off the house. Those of you that want to be ultra conservative and pay only on the house, should probably take a little bit of a risk and save for retirement in stocks. Your personal situation will determine how much should go to one or the other. Please share your thoughts or personal experience in the comments below.