My Mortgage Dilemma – Prepay or Invest

Posted on October 8, 2007 by Eric 
Filed Under Mortgage

Those look like nice homesIt’s not quite so easy as it sounds. To some folks, they can immediately answer one way or another. If your interest rate is below 8.5% (I learned this by reading Pinyo’s analysis of prepaying your loan vs. investing at Moolanomy), depending on things like inflation and how well the stock market does, you’ll almost always come out ahead investing your money. Read that article and all the ones he links to at the bottom and you’ll get a real education on prepaying vs. investing.

At first, reading that article made me kind of depressed. Until early this year, I was paying an extra $100 toward the house payment each month. I didn’t stop paying it because I knew it would be better to invest the money, instead I stopped paying it when I realized it didn’t make sense because Melissa and I had already committed to buying a new house. That extra hundred went into investments in preparation of the new home.

But now, after reading all those articles, and doing some more thinking myself, I don’t feel as bad about my prepaying the mortgage. Sure, I could have made even more money if I hadn’t spent years investing that extra monthly $100 into the house. But sometimes personal finance is more than just seeking the absolute highest returns, or the absolute best interest rate, although I do see those as fantastic goals. At some point, you need to balance this with your personal level of acceptable risk, and balance it with your personal values.

Because we are moving (hopefully before the end of the year if the house is finished), I have to face this decision again. The financial part of me says invest anything you might have otherwise considered paying toward the principal. But there is another part of me that says that the house is a physical asset that can’t be taken away from me once I own it.

I’m going to have find a balance between my desire to own my house outright, and my desire to increase my net worth so I can retire early.

Even though something can make so much sense when you “do the math” or “look at the numbers”, it doesn’t always calculate when you take all the factors into consideration. What If I lose my job? That puts my house at risk because I don’t own it outright. What if we go through a bad recession? That could reduce the amount of return I’d make on my investments. What if we experience high inflation rates? Again, this can affect my savings and investments, but real estate tends to fare better against inflation.

Because we are getting an 80-10-10 loan (we are paying 10% down, getting one loan for 80%, and another loan for 10%), I am considering paying down the 10% loan aggressively. It will be at a higher interest rate and therefore costing me more in interest. Once the second loan is paid down my overall house payment will immediately drop. This extra money will go directly into investments. I think this way I can balance my desire to pay down my mortgage more quickly (even though I’ve still got 30 years left on the 80%), and my desire to invest more of what I bring home.

Image source tofslie

Comments

10 Responses to “My Mortgage Dilemma – Prepay or Invest”

  1. Pinyo on October 8th, 2007 6:18 am

    Eric – Your thinking is right on. Many times we can’t just go for the highest return option. Real life example, for the past 7 years the market only return an aggregate of about 3% per year. In this case, you are better off pre-paying that mortgage. Pre-paying is 100% certain, whereas, relying on stock investment to beat pre-payment is possible on average.

  2. Eric on October 8th, 2007 7:16 am

    Pinyo – I’m seeing that now. But at the same time, if the market had a better return, I could easily have wound up making more money had I invested it instead of prepaying the house. For the first few years of the mortgage, I would have been better off investing than prepaying. The real dilemma comes from the risk of investing. There are no guaranteed returns in the stock market, but with the house it’s at a set price with a definite end.

  3. Elizabeth on October 10th, 2007 2:16 pm

    Eric, I enjoyed your post. My husband and I purchased a house almost 5 years ago. I’m a first-time home-owner; my husband has owned many houses over his lifetime. Soon after buying our house, I read somewhere that a homeowner could take an average of 8 years off a 30-year mortgage simply by making one extra house payment per year. I mentioned the fact to my husband and we agreed to adopting that policy. And we’ve stuck to it. Could we see a larger return if we invested that money instead? Probably. But as you said, one needs to assess their personal values. My husband has cancer. He’s being treated but due to the nature of the cancer, he cannot be “cured.” We have two teenaged children. I live daily with a cloud of insecurity and uncertainly about our future. For me, the security of knowing that if and when my husband dies I will be that much closer to owning my our home surpases any hope of what “could have been” if we’d invested those payments in the stock market instead. My home is real and solid and provides me with a sense of security on a daily basis. The uncertainty of the stock market would offer me no comfort.

  4. Eric on October 10th, 2007 4:00 pm

    Elizabeth – thank you very much for sharing your story. I’m sorry to hear about your husband. It sounds like you made the right decision for your situation by making those extra payments. The peace of mind of owning your own home is sometimes worth more than money.

    I think your story here highlights exactly why it’s not always about the numbers. Again, thank you very much for sharing your story, and Melissa and I wish you and your family the best.

  5. Dave Ramsey’s Baby Step 6: Pay Off Home Early | Moolanomy on March 5th, 2008 8:04 am

    […] My Mortgage Dilemma – Prepay or Invest at A Penny Closer […]

  6. Dave on March 5th, 2008 11:30 pm

    Here’s a link to an article by finanical columnist Scott Burns which swayed me to pay off my mortgage:

    http://www.dallasnews.com/sharedcontent/dws/bus/scottburns/columns/archives/1999/990525TU.htm

    The gist is, “imputed income”, i.e. a paid off mortgage, provides benefits that are not received in cash but which have a cash value.

  7. Mark Viner on May 27th, 2008 2:56 am

    Hard decision. We have dilemmas when we want to buy a camera, a car, but at homes… very hard decision.

    I think the best way to find out what fit best for you is consulting a mortgage calculator: http://www.maracal.com

  8. Fast Loan UK(new comment) on August 26th, 2008 2:22 am

    it’s quite a hard decision indeed, but i think you’ve made the right thing. :)

  9. Craig M.(new comment) on October 5th, 2009 1:37 pm

    Here’s a link to an related article that I found in Google News written by financial specialist Paul Michael from Michigan: http://www.amortization-tools.com/top-articles/45-mistakes-seeking-loan.html

  10. William Alexzander(new comment) on November 19th, 2009 11:19 pm

    In recent times, the mortgages and real estate prices have become unstable, owing to the uncertain market conditions. As a result, many homeowners are considering qualifying for loan modification facilities. One can gain, by investing in foreclosure homes in Canada.

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