Lets look at a basic example of someone who has bought a $250,000 home. Current interest rates are at historic lows for mortgage loans. Someone today may be able to get a 30 year fixed mortgage for 3.00%. That’s what we will use to set up this example. If someone has a $250,000 mortgage loan that is set up on a 30 year term with a fixed rate of 3.00%, then their monthly payment would be right at $1,054 a month. That does not include any taxes or insurance, strictly the mortgage payment by itself. You can go to any mortgage loan calculator online to get this information. I went to mortgagecalculator.org for these calculations.
Now, you are contemplating whether you want to pay extra on your mortgage loan or if you should take that extra money and put into your retirement savings that would be invested in a diversified mix of stocks and/or bonds. Lets say you want to pay $500.00 extra per month on your mortgage payment. By doing this, you would cut your mortgage down to be paid off in 17 years and 3 months with a savings of $59,242.14 in interest. That’s a huge savings over time and it almost cuts your mortgage term in half.
Instead of putting $500.00 per month into an extra principal payment on your mortgage, lets look at putting that $500 into a retirement account that is invested in the market, and we will assume an average of a 7% return compounded annually. We will also only do this for 17 years, since that would have been the length of time your mortgage would have been paid off. If you save $500 a month for the next 17 years at a compound annual rate of 7%, at the end of the 17 years, you would have roughly $190,905.53. You would have put in $102,000 of your own money and your funds would have grown by roughly $88,950.53. You can find many different investment calculators that will make these calculations for you as well. I used calculator.net for the calculation.
Let’s take that one step further. After the 17 years, let’s say you continue to put $500 a month into a retirement vehicle that continued to grow at roughly 7%. At the end of 30 years, which would be the same time you pay your mortgage off, you could have $584,726.30. You would have contributed $180,000 of your own money and it would have grown by $404,726.30. And now you don’t have a mortgage payment and you’ve got a nice nest egg built up.
Some people may say, they want to pay their mortgage off early, then they’ll put more money in their retirement. Let’s say you added $500 to your mortgage payment, it was paid off in 17 year, then you decide you would put $1,000 a month to your retirement vehicle that would grow at the same 7% return over the next 13 years, which is the same time frame as the 30 year mortgage, just to keep all the numbers on the same time levels. By the end of the 13 years, you could have roughly, $249,347.14. That’s less than half, of what you could have had, if you would have just done the $500 a month for 30 years.
What if you put $1,500 a month in your retirement vehicle after you paid off your mortgage, since you were paying the $1054 on the payment, plus the $500 extra dollars. At the end of the 13 years, you would have roughly $374,020.71. Still not any where near what you could have had if you would have put the $500 a month in the retirement vehicle form the beginning instead of paying extra on the mortgage.
Its quite obvious with some basic calculations that in the long run, the potential for your retirement is much greater than the mortgage being paid off early. Another thing about the mortgage interest, it’s tax deductible, so you’re potentially not paying near as much in interest as you might think due to the tax advantage of paying that interest.
Maybe you have just switched jobs or have access to your 401k or retirement vehicle for some reason, and you are contemplating whether you should pay off your mortgage from your retirement funds. If you are not at the eligible retirement age for that distribution to be taken without a penalty, which is usually 10%, I do not recommend doing so. Even if you are at the eligible age to take a distribution without a penalty, you still have to consider the tax consequences of that distribution because depending on the vehicle, it could be 100% taxable. If you took $100,000 out and let’s say you would be taxed at 20%, then you’re only getting $80,000 net out of the distribution. Another potential issue is that distribution could bump you into a higher tax bracket, which would increase your over tax rate and that could cost you more money than you may want in taxes. Is there a time when it makes sense to do this? Possibly. It just depends on your situation. If you are staying up at night worrying about making your mortgage payment, then it is probably beneficial to your health to pay it off. Is it usually the most financially responsible option, not usually.
Another thing to consider, if you were contemplating paying your mortgage off sooner, but saw the advantage of how much you could save over time by adding those funds to a retirement account, you can choose to do a combination of both. You can pay an extra $100 or $200 a month on your mortgage and save $300 or $400 a month in a retirement vehicle. There’s no right way or wrong way. Ultimately, it comes down to your goals and game plan.
Hopefully, these examples have helped your out if you had ever wondered about paying more for your mortgage. Maybe these numbers made you think a little more about putting some more in your retirement account too.