Should I pay off my loans early or invest that money into the stock market? This is a great question that I was faced with at one point and I'm sure you guys can guess which route I took. I'm sure every person arrives at this question in some point of their life. There isn't really a right way or a wrong way but I'll explain why I chose to invest vs pay down my loans early.
Now right off the bat, I don't want anyone to get confused by loans vs debt. I think every investor will tell you that if you are in credit debt, or any other short of high interest debt, you should always pay that off before choosing to invest your money.
This article is going to strictly focus on loans such as Auto loans and mortgage loans. Most Americans deal with one of these loans in their lifetime so I really want to focus on the reasons why I'm choosing to invest my extra money.
Many Americans know what it feels like to have have a mortgage that they owe upon every month. In fact, according to the US Census Bureau 64% Americans own a home, so many of them have had a mortgage in their lifetime. The most common type of mortgage is the 30 year conventional loan. Now, assuming that The average american purchases a home at the age of 25. Also assuming that they don't pay any extra into the principal of the mortgage, they will not be paying it off until they are 55. YIKES!
Many are probably thinking to themselves that they should pay it off early instead of invest. I'm not saying that this is a bad idea. But their are a lot of factors that pertain to peoples individual lives and for me it makes sense for me to invest that money. I was very lucky to be able to purchase my home at 25 with a great interest rate of 4%. The closing price on the home was $129,000 including all closing costs and fess. I showed up to the table with $19,000 and financed the $110,000.
I have always had a goal to pay the house off early but i'm not going to take away from my investments to achieve this. One way I pay a little extra into my mortgage every month is pay making an extra payment every year. I do this by taking my normal monthly principal payment and dividing it by 12. Doing this will cut an easy 5 years off my mortgage by only having to pay an extra $44.52 every month.
Now one could easily argue that it would be better to pay the house off sooner because year to date I have paid $3,055.87 towards interest on my mortgage. A few reasons that I would rather invest my money is because the overall potential I have in the market for investment growth and the steady dividends I receive annually. Currently my annual dividend payout sits at $668.36 Annually. My total portfolio currently represents a dividend yield of 4.05%. I'm already above my interest rate that I pay on my mortgage. If I combine that with the average reported mortgage deduction refund by the Center of American Progress of $523, then I'm currently paying $2,320.11 Yearly for interest on my Mortgage.
If I continue to follow the same trend of saving and investing as I have so far this year, I expect my dividend payout to be at $1,600-$1,800 next year. Not only do I actually have money that I can use as back up if I really needed to sell some stocks and withdraw some money, I'm actually increasing the amount of money I make each year. Now this is just simply focusing on what I will be receiving from dividend pay outs. If I add what the average performance of the S&P 500 is then I'm making even more money that is counter acting my mortgage interest. After adjusting for inflation, the average yield since inception is 7%. Combine that with my dividend yield makes for a pretty nice amount of growth. The only other factor that one could argue for paying off the mortgage loan first is that one must pay taxes on dividends received if it is distributed into a taxable brokerage account. Since I'm in the 15% tax bracket though I will not have to have any interest on my dividends received.
The above information is true to the same way that I would handle paying off an auto loan early. Since my Auto loan rate is super low at a mere 1.99% I will not be making any haste to pay it off sooner. Even if I combined the two Interest percentages, I would much rather be investing into solid paying dividends stocks that have the ability to grow dividend pay outs through the years and increase the overall value of the company. Stocks are historically going to increase in valuation and my loans are going to decrease month by month.
Now the only way I would choose to pay off the auto loan sooner is if it made sense for me to do so. If the auto loan got to a certain dollar amount where I could easily pay it off without really affecting the performance of my portfolio, then I would simply go ahead and do that as long as I continued to payout what I'm saving on my auto loan payments into my Independence Fund.
Everyone has a different way of doing things and different ways of viewing situations. Some people would rather knock that mortgage payment down to $0 as quick as financially possible. I'm fine with taking my time to pay it off while having the ability to build up my Independence Fund month by month. I have managed to growth my portfolio from $0 - $17,454 in only 8 months! This is money that Is working hard for me everyday so eventually I won't have to do the hard work. I couldn't even imagine eliminating my current portfolio value to pay it into my mortgage balance and be left with just a smaller number that is fixed every month.
The thought of that is very depressing since this Fund represents more then just a number to me. This Fund is a Journey towards Financial Freedom. This Fund is a driving factor for all my actions lately. I'm constantly making continuous decisions on weather I should buy something or invest the money I would save into the fund. It has given me great satisfaction and an overall feeling of accomplishment to see how far I have come in such a short amount of time.
My motivation is driven by the shear progress that I can look back on an think to myself, "wow, I did all that on my own" That to me is worth more then paying down my mortgage or my auto loan early. Now, don't get me wrong. Having a paid off house is essential towards financial freedom, but I have plans for that which I'll talk about in another article sometime.
Hopefully everyone enjoyed and thanks for stopping by
Please feel free to leave a comment below as I would love to hear some thoughts on this topic if anyone has chosen to do it differently.
Kevin Dolan (A.K.A Kevin Dolan)
Image courtesy of iosphere at FreeDigitalPhotos.net