With mortgage rates low and stocks on a roll, current and prospective homeowners should consider whether it’s best to put more money into their mortgages or to invest in stocks or other holdings instead.
There’s a case to be made for either approach, depending on how much risk you can stomach and how dependable your income is.
The mortgage-versus-investment issue generally comes up in two ways.
The first confronts people who are shopping for new loans and deciding whether to make payments over 15 years or 30. Interest rates on 15-year fixed-rate loans are slightly lower, at 4.92% compared to 5.399%, according to the BankingMyWay.com survey.
But the big difference involves the faster payoff. By getting rid of the loan in 15 years rather than 30, you can slash interest costs. On the other hand, the 15-year loan requires much larger payments to retire principal twice as fast. That extra money could be invested in some other way if you got a 30-year loan instead.
A similar issue arises when homeowners consider whether to make extra principal payments to retire a mortgage early. Prepayments have the same effect as choosing a loan with a shorter term: reducing the principal, or outstanding debt, reduces interest costs.Paying more each month obviously requires a bigger income. But if that’s not an issue, does it make financial sense?
It depends on the alternatives. The bigger payments required on a new 15-year loan taken out now would, in effect, “earn” an investment return of 4.92%, since you’d avoid 15 years of interest payments at that rate.
Extra principal payments on a 30-year loan would work the same way. The investment return on those payments would equal the interest rate on the loan, or 5.399% on a new 30-year loan taken out at today’s average rate. (Prepayments on adjustable-rate mortgages work a bit differently.)
If you could earn a bigger return with another investment, the bigger mortgage payments would not make sense. Stocks have been on a tear recently, with the Standard & Poor’s 500 up more than 50% since early March. During that period, money would have earned much more in stocks than in bigger mortgage payments.