Last week, I broke down how your mortgage works. It’s actually a 360-month, 0.33% mortgage because the interest payment is recalculated every month.
So if you pay an extra $1,000 per month into your 4%, 30-year $1M mortgage, you’ll save $3.30 each month in interest. That means you’d $150,000 in total interest and pay off your mortgage in 21.66 years.
But is that the best you can do?
The Opportunity Cost of Making extra mortgage payments
Whether or not saving $150,000 in interest is a good deal all depends on what else you could do with that money.
What if instead of putting that extra $1,000 a month into your mortgage, you used it to invest in an S&P 500 index fund instead?
Over the last 100 years, the long-term average return of the S&P 500 was about 10% per year.
That means you’d EARN $8.33 per month by INVESTING your extra $1,000 per month instead of paying down your mortgage ($1,000 x 10 / 12 months).
So now your choice is:
- SAVE $3.33 a month or
- MAKE $8.33 a month
Imagine if someone walked up to you in the street and offered to either:
1) Buy you a Starbucks or
2) Give you $8.33.
Obviously, you’d take the money (after thinking about running very fast in the other direction from this crazy person). You’d still get your Starbucks AND have an extra $5 in your pocket.
Pay off your mortgage even faster
In 17.5 years, the $1,000/mo you put into the S&P 500 will have grown to equal the remaining balance on your mortgage.
You’d have $565k left on your mortgage and $565k in your portfolio.
So if you really wanted to, you could pay off your mortgage right then and there.
By contrast, if you had poured all that money into extra mortgage payments, it would be another 4 years before your mortgage is paid off.
So if your end game is to get rid of your mortgage as quickly as possible, then investing your savings will get you there quicker than dumping it into your mortgage.
But you should never pay off your mortgage
But your end-game should never be to pay off your mortgage. Your mortgage turns your home into an asset that actually earns money.
A paid-off house just collects dust. Sure the equity will grow slowly over time, but home equity can’t buy groceries or pay for vacations.
And more on that next week…
