Owning a home outright is a dream that many Americans share. Having a mortgage can be a burden and paying it off may be the first item on your financial to-do list. But competing with the desire to own your home free and clear is your need to invest for retirement, your child's college education and evaluating your liquidity. Putting extra cash toward one of these goals may mean sacrificing another. So how do you choose?
Evaluating the opportunity cost
Deciding between prepaying your mortgage and investing your extra cash isn't easy, because each option has advantages and disadvantages. But you can start by weighing what you'll gain financially by choosing one option against what you'll give up. In economic terms, this is known as evaluating the opportunity cost.
For example, let's assume that you have a $300,000 balance and 20 years remaining on your 30-year mortgage, and you're paying 6.25% interest. If you were to put an extra $400 toward your mortgage each month, you would save approximately $62,000 in interest, and pay off your loan almost six years early. By making extra payments and not paying all of that interest, you'll clearly be gaining a lot of financial ground.
But before you opt to prepay your mortgage, you still should consider what you might be giving up. Start by looking at the after-tax rate of return you can expect from prepaying your mortgage. If you itemize deductions on your tax returns, factor in any tax deduction you receive for mortgage interest. Once you’ve calculated that figure, compare it to the after-tax return you could receive by investing your extra cash. Which one is higher?
Keep in mind that the rate of return you'll receive is directly related to the investments you choose. All investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will be successful. Investments with the potential for higher returns may expose you to more potential loss of principal, so take this into account when making your decision.
Other points to consider
While evaluating the opportunity cost is important, you'll also need to weigh many other factors, including:
The middle ground
If you need to invest for other goals, but you also want the satisfaction of paying down your mortgage, there's no reason you can't do both. It's as simple as allocating part of your available cash toward one goal and putting the rest toward the other. Even small adjustments can make a difference.
And remember, no matter what you decide now, you can adjust your strategy to keep up with changes to your circumstances, market conditions and interest rates. The experienced team at Busey Wealth Management can help you develop a solid plan for your financial future. To learn more or to find an advisor near you, visit busey.com/wealth-management.
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.
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