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Is it better to pay off your mortgage or invest that money to create income to pay the mortgage?

That’s a question I’ve been mulling lately, and with the help of some finance tools that we use, the answers may surprise you.

There are all kinds of ways to look at this, and it depends on your situation.

As we get close to our retirement years, I wanted to examine the question of whether I should pay off my home early, or use the money to invest. Since we invest in mortgages, I understand them as vehicles to earn passive income. But if I’m the one paying, then it looks a little different.

Let’s say you want to quickly pay off your $270,000 house with a $225,000 mortgage. That’s a slightly above median list price of homes currently for sale in the United States, which Zillow sets at $255,990.

For our demonstration, we’ll set the mortgage at a fixed interest rate of 4.5% on a 30 year mortgage.

The 30 Year Loan Payoff

It looks like this:

Number of PMTS Interest Rate/Yr Present Value Payment
360 4.5 225,000 1140.04

The 15 Year Mortgage Payoff

If you simply paid it off over 15 years, tossing in an extra payment every month, it would look like this:

Number of PMTS Interest Rate/Yr Present Value Payment
180 4.5 225,000 1721.23

You can accomplish the same thing with a single extra payment of $7,000 in the beginning of the year, if you prefer. What’s great about this, is that if you’re 50, and you use the 15 year option, you’re home free by age 65.

The 10 Year Mortgage Payoff

Let’s look at two more scenarios:

Number of PMTS Interest Rate/Yr Present Value Payment
120 4.5 225,000 2331.86

This pays off the house in 10 years which looks great. But let’s go crazy and see what it would look like if you paid it off blazingly fast in just 5 years.

The 5 Year Mortgage Payoff

Number of PMTS Interest Rate/Yr Present Value Payment
60 4.5 225,000 4194.68

That would bust most people’s budgets, right? If you subtract the 30 year payment from the 5 year payment, you’d be paying an extra $3054.64 a month. That’s a take home pay of $36,655.67 per year, which is about the size of the salary of a mid-level administration position. It could also represent a reasonable annual income from a successful side business, like consulting, paying about $75 an hour.

But wait a minute. That means if a two-earner household used one person’s income to pay off the house quickly, it would be possible in just five years.

If your main income earner is bringing in $75,000- $100,000, it’s totally doable if you take the challenge seriously. After 5 brief years, you’ve saved not only $225,000, but you’ve avoided paying $158,735.11 in interest. Here’s what it looks like:

  • Interest paid @ 4.5% on $225,000 over 30 years: $185,415.85
  • Interest paid @ 4.5% on $225,000 over 5 years: $26,680.74
  • YOU SAVED: $158,735.11

Beautiful. Brilliant.

But what if you socked away that extra payment of $3054.64 a month over 60 months and it went into a Roth IRA paying 12%, a reasonable target in the note investing business? It would like this:

The 5 Year Mortgage Payoff Through Investing

Number of PMTS Interest Rate/Yr Future Value Payment
60 12.0 $245,415.42 $3054.64

In this scenario, your massive savings effort means you can pay off your house in five years, and STILL have money left over. Let’s see how much that comes to…

Using the 30-year mortgage payment of $1140.04, at the end of 60 months, when you’ve accumulated $245,415.42, and you pay off the remainder due on 25 years of house payments, you’d owe $205,105.46. Subtract your investment stash, and you get to keep $40,309.96 still in your Roth.

Let’s lay this out:

  • Paid into Roth account over 5 years:                      $183,278.40
  • Accumulated investment with interest:                 $245,415.42
  • House Payoff Amount after 5 years:                       $205,105.46
  • YOU KEEP:                                                                    $  40,309.96 PLUS THE HOUSE

Now this assumes that the monthly payments of $3054.64 into your Roth are post-tax, so your earning target for the second earner or that side consulting job is about $4,000 a month.

If you’ve got a solo LLC and you’re over 50, it makes it easier to throw that much into your Roth. Remember, you can withdraw what you’ve invested into your Roth at any time without penalty, so you don’t have to wait until 59 ½ to pay that house off.

So it’s up to you. You can pay the house off in a reasonably easy 15 years, or you can go crazy and push it through over 5 years with some hard work for a short time. The payoff looks pretty good to me.

 

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