Should I put extra money towards paying down principle on my home, or invest it?

Question

At the end of each month, I usually have about $100 extra, left over, that I don't need to spend on anything with. I want to put that extra money towards building my equity, but I'm not sure where the best place to put it is.

I guess one option is to pay down extra principle on my home loan. I am only paying 5.75% interest, though, and since some of that interest is tax-deductible, would I be better off investing the extra money in mutual funds/stocks? I figured that after subtracting the tax benefits of writing off interest, I'd be saving only about 4.14% annually by putting extra money into my mortgage payments.

So I'm leaning towards investing in stocks/mutual funds, as I think I could get a better annual return than 4.14%. I maxed out my IRA and am putting 6% of my paycheck towards my 401k (which is the max that my company will match). Do you think I should put the money to stocks/mutual funds on my own or used more than 6% of my salary towards my 401k?

I guess to add to my original post, I am only in my late 20s and already have a 15 year mortgage. Also, I have a high risk appetite and am looking to strong growth in my investments over the coming years.

Answer 1

You should make sure you have a sufficient 'ready reserve' of savings for reasonably foreseeable events that might take place.

What if you suddenly need a major car repair, or you need dental work. or home repair? You should have a certain amount of lliquid capital available to you for when those things happen, because they almost always happen at some time or another.

The stock market is not liquid in the sense that you should not consider a stock investment a 'ready reserve'. If you need the money and may have to sell now, you will likely not get the average return you envision.

If you are looking at $100 per month, that's $1200 per year. Invested evenly per month, you are looking at an 'average balance' of just over $600. Even if you were to make 10% interest (a higher than market rate that you probably won't get in the stock market), that is $60 per year. If you put the money in a bank and get 4% (check out the ING Direct account, currently paying 4.5%, for an account that pays in this range), you would earn $24, so you are talking about trying to figure out how to earn about $36 more.

Having the liquidity of the savings account is probably as valuable of an asset as you can get with your extra $100 per month. Once you have a sufficient ready reserve (maybe two months of income, or some other benchmark that is your comfort level), then you might look for higher yielding investments like stocks. But don't worry so much about 'interest rate' for amounts like $1000....you're much better off keeping it liquid.

One other thing about your home - if you had a home equity line of credit with a balance, you should consider paying that down, because that is liquid and you can always get it back if needed. The mortgage, however, cannot be easily accessed once it is paid down.....if you need that money back, you would have to apply for some other line of credit. Unless you have sufficient ready reserve, the interest savings isn't worth it.

Answer 2

That's great that you max out your IRA. Most people can't achieve that. And you been saving in your 401k too. I find out that most 401k's don't do as well as IRAs because people have no clue how to invest in their 401k. They just randomly pick mutual funds and stocks that has high numbers. Though, I wouldn't fund a 401k with stocks since they are highly volatile and risky.

What do with the extra $100? You can apply it to the mortgage payment. I hope there's no early prepayment penalty on it. If you want to pay off the mortgage faster, ask the bank if you can pay it bi-weekly. Bi-weekly payments split your monthly payment in half. For example, if you were paying $1000/month toward the mortgage, you only have to pay $500 every 2 weeks. Most people get their paycheck every 2 weeks.

OR maybe you should use the extra $100 and start an emergency fund. An emergency fund is an account where you have easy access to and will last you for another 3-6 months in case something happens to you such as losing a job or being hospitalize.

Another suggestion is invest systematically in your IRA. Most people prefer to put one lump sum every year into their IRA. While that is good, they don't know if they are buying shares when market is high or when it is low. When you invest systematically, that means you put in $300 every month in the IRA. What this does is lower the cost per share. If you understand the dollar cost averaging concept, you would see how that lower the cost per share. Whatever is left over at the end of the year, then you max it out.

Answer 3

I think you totally have your stuff together and should be answering more questions than you are asking. Here's my two cents though...

You could use the extra $ to pay off your mortgage early. Move to a better place and rent out your old domocile. Use the rent income to pay on your new mortgage. Repeat this process until you have established enough rental income to make some serious commercial or land investments.

Or, you could save up your $ and take an extra vacation each year to have some fun and take your mind off the stress of thinking about how to make more money. Remember, life is short.

By the way, Kudos to all those great responses to this question.

Answer 4

Most importantly, DO YOUR HOMEWORK!! Look at overseas markets, especially China. Don't risk any more than you can afford to lose, and make sure you diversify. In the US, any good medical, pharmaceutical, or recreational company that makes products especially for older folks. The US is experiencing a rapid aging process due to the Boomers getting older. Also, life expectancy is getting higher. Real estate is good too. Look at areas where the older folks are migrating to for retirement and buy some unimproved and well located land 10-20 miles outside city limits of a medium size town that is growing and has things retirees want and need. Then, just pay the taxes and sit on it for a few years and resell it when the profit is right. At your age, good long term investments can make you a millionaire by the time you're 50-60 years old.

Answer 5

Make sure you have an emergency fund equivalent to 3 to 4 months pay. Do you have other debt? If you have credit card debt this is a good time to pay them off completely, the savings you can achieve here far excede a return of 4 or 5 %.

Your calcuations show 4.14% savings. Did you factor in inflation? If you have and all you can actually save is 4%, then I'd say don't do it. You'll actually be losing money, because you will be 'earning' 1.2% below federal interest rates (minimum rate). You can easily earn 5.3% by investing in T-bills

Answer 6

I think there are other things to consider. Such as, do you plan to stay in this house or sell it in the near future. If your current mortgage is assumable it may make your house attractive when trying to sell it assuming that you do not have a significant amount of equity currently. If you are planning to stay in the house for an extended period of time, you may want the satisfaction of owning it outright. You must realize that you will need to earn at least 5.75% on any taxable investment to match (after taxes) the return of paying down your mortgage. If you decide to invest, I would suggest a low expense, index-type, diversified, mutual fund to limit investment expense.

Answer 7

I am tempted to suggest paying down the mortgage. A bird in the hand is worth 2 in the bush. But you do not say how much of a cash cushion you have. If you do not have one you need to build one.

Answer 8

Use the money to pay down your mortgage. Your home is your first investment, you don't need to risk your money looking for other investments, you could lose it.

Answer 9

It depends on your age, # of years to retirement, etc. If you have a 30 year loan you could you could pay on it as if it was a 15-20.

Answer 10

either way its a win win situation for you. me i would invest it.