If you do the calculations, and make a decision purely based on the numbers, then paying down your mortgage might not be the best investment. Putting the extra money into the stock market might get you a better return, especially in the current low interest market. However, i’m using freedom in the equation, and then things change for me.
Let’s first look at the calculations, i’m using my own situation as an example:
I have around 420K of mortgage left to pay, at an interest rate of 2,3%. Currently I have a pretty good amount of savings I can set aside (around 50K per year as a family). I have two options: invest this money, or make extra mortgage payments every year. My fixed mortgage (principal) payments are around 10K per year. I have two options with my savings:
- Scenario A: Extra payments on my mortgage
- Scenario B: Invest
The coming 7 years, this looks as follows:
Comparing the options
In scenario A, I will have my mortgage paid off completely in 7 years. I will have no extra investments built up. In scenario B, I invest all the extra cash in the stock market, and assuming an annual year on year return of 7%, I would have 432K after 7 years. This is enough to pay the mortgage at the end of year 7 (which will be around 350K because I only did the fixed principal payments).
I would have an additional 82K of investments after paying the entire mortgage.However, in scenario B I also pay almost 20K in additional net interest payments, and another 19K in capital taxes. In the Netherlands, you don’t pay capital tax on your home, however a form of tax on your home will now be slowly introduced in the coming 30 years. Taking the tax and interest payments into account, scenario B comes out +44K in favour of scenario A.
Both scenario’s will lead to not having a mortgage anymore after 7 years. This is great because:
- Having no mortgage (and even calculating that there is a possibility to be mortgage free in 7 years) gives me a sense of freedom and control. Mentally, I feel I already took a small step towards financial freedom. When the mortgage is paid of completely, it will be a big step;
- In 6 years my fixed interest rate period will expire. Interest rates might stay very low for another couple of years, but there is a possibility of rising interest rates as well. An increase from my current 2,3% to 4,6% is not unlikely. This would double my yearly interest payments (against my objective of lowering spending);
- Also in 6 years, my oldest will be starting university, if all goes well. This is the start of a very expensive period will (specifically if our youngest starts Universtity two years later). It will be easier for me to pay for university while having no more mortgage payments.
The problem I have with scenario B:
I like seeing the mortgage getting lower every year, this increases my feeling of freedom;
Investing money, while you still have a mortgage is investing with borrowed money. This can go wrong;
The stock markets might not return 7% annually the coming 7 years;
When accumulating the extra cash, I might not invest all of it, perhaps even be triggered to start spending more, because i will feel rich: with hundreds of thousands of euro’s on my bank / investment account!
What the extra freedom and peace of mind is worth to you is the big question. Not having a potential extra financial benefit of 43K is worth it for me.
As every situation is different, I encourage you to do your own calculations and check what is best for you. Some points to take into account:
- The taxes in your country might have a different impact then the situation in the Netherlands;
- The number of years required in your scenario will have a big impact, e.g. if I calculate 15 years of investing versus mortgage payments, the investment scenario will win with a greater margin due to the power of compounded interest;
- You need an emergency fund. When all your extra cash is put into the mortgage, this will be difficult to get out.
Photo by Nicole Baster on Unsplash