Paying off your mortgage gives you freedom from a lender and a sense of relief from the debt hanging over your head. It means you finally own your home.
However, the idea of investing your money into another piece of property or home is enticing. It could mean a bigger cash return later, whether you flip the house or rent it out.
Deciding between paying off your mortgage or investing is complicated. To help you make the right choice, we’re reviewing the pros and cons of each. There’s no right or wrong answer. It all depends on what works best for you.
Factors to Consider When Deciding Between Paying Your Mortgage or Investing in More Real Estate
Before sitting down and making a decision like this, there are several things you should consider. These are questions you should ask yourself before making any real estate investment decisions in your life. They include:
What type of real estate investment are you interested in?
No matter what type of real estate investment you currently have, you may want to dip your toes into other types.
There are tons of investments to choose from but the top choices include investing in land, flipping residential homes, commercial real estate to rent out office space, or industrial real estate which includes buildings like warehouses.
Go over your choices. You don’t have to keep making the same investment decisions to be successful.
What Is Your Expected Return on Investment?
An expected return on investment is the profit you expect to make from your investment after all the expenses are covered. Depending on what type of real estate investment you’re interested in, your expected return on investment varies.
To calculate your expected return on investment, you need to know your investment gain as well as the investment cost of the property or house. Once you have these numbers calculated, you subtract the investment cost from the investment gain.
Next, divide this number by the investment cost. This expected return on investment is based on a percentage instead of a specific dollar. The final number will be a decimal that you will have to convert to a percentage.
To figure out the percent, multiply the decimal amount by 100 or move the decimal point two places to the right.
It’s often easier to use the out-of-pocket expected return on investment method instead of the standard return on investment formula.
Say you took out a loan or mortgage from a lender for the property. To take out this loan, you have to provide a down payment to this lender. Add this down payment to the extra expenses. Expenses on a piece of property or house can include many different things but the biggest expenses usually revolve around repairs.
Once you have this number calculated, subtract it from the entire property cost. This is your equity amount.
Divide the equity amount by the total cost of the property. Again, you’ll receive a decimal amount that you’ll need to change to its percent equal.
What is Your Risk Tolerance?
Risk tolerance varies from person to person. This is the amount of market risk that you feel comfortable to take within your finances.
There are aggressive risk-takers, moderate risk-takers, and conservative risk-takers. None are superior, it just depends on your financial situation and what you feel comfortable with.
Once you’ve figured out what type of real estate investment you’re interested in, you have to consider some worst-case scenarios.
Can you handle that type of hit mentally?
Don’t confuse risk tolerance with risk capacity. Risk capacity is the amount of risk that you can afford to take if things were to fall through. But it’s just as important, if not more, than your risk tolerance.
Can your finances handle that type of hit? This is something you need to determine through your finances. Crunch the numbers with the help of an accountant so you know that the numbers are correct.
The Pros of Paying Off Your Mortgage Right Away
First, the pros of paying off your mortgage right away instead of investing in more real estate right away.
1. You’ll Be Anxiety Free About Your Loan Debt
If you pay off your mortgage immediately instead of investing, a giant weight is lifted off your shoulders. Your debt is paid and you own your property.
If you miss your mortgage payments because of an emergency, you can lose your house. When you pay off your mortgage, you don’t have to worry about losing your home.
Plus, that heavy debt is wiped from your credit report which boosts your credit profile so you have more investment opportunities in the future.
2. You’ll Have Extra Money in Your Pocket Each Month
Once your mortgage is paid off, you have the extra money in your pocket each month which gives you a lot of wiggle room in your budget and some money to play with.
Use this money to save and invest in real estate later or cover new expenses or even treat yourself to something nice.
The options are endless and it’s always a bonus to have the extra money in your bank account.
3. It Reduces Your Debt to Income Ratio
Your debt to income ratio is your monthly debt payments divided by your gross monthly income.
Once your mortgage is paid off, your debt to income ratio drops.
If you’re looking to take out another loan, a lender will go through your financial history, which includes your debt to income ratio. If your ratio is 43% or less, the better your chances are for another loan.
4. No More Interest Payments
The longer it takes you to pay off your mortgage, the more you pay in interest. This takes extra money out of your pocket and adds up quickly.
The faster you pay off your mortgage, the less you’re paying the lender.
Not to mention, most lenders expect you to have private mortgage insurance which is another expense out of your pocket each month. So, when the mortgage is paid off, you’re saving even more money.
5. You Gain Equity
Once you pay off the mortgage on your home or property, you gain equity. When you’re still paying on your mortgage, the lender owns a piece of your home. When you pay off that lender, the home is all yours. So, if the property value rises throughout the years, your home’s value rises, too.
Nobody else gets a piece of that equity. It’s all yours. The higher the equity, the better.
The Pros of Investing in Real Estate
There are also benefits to investing in real estate before paying off your mortgage
1. You Can Borrow More Money to Invest in Real Estate
You wouldn’t think that lenders worked this way but paying off your mortgage early instead of investing in more real estate can make your life more difficult in the future.
If you need a loan a few years down the road for another piece of property, you may not qualify. If you do qualify for another loan, the interest rates may be incredibly expensive.
2. You Won’t Lose Your Mortgage Interest Deduction
When you pay your mortgage off early, you lose your mortgage interest deduction.
Your mortgage interest deduction is a tax deduction that you receive every year you’re still paying off your mortgage. With this deduction, your income is taxed less than it would be without the mortgage.
Keep in mind that the qualifications for a mortgage interest deduction have changed over the years and you might not qualify for this tax break.
3. You’ll Make More Money
It’s no secret that investing in the right piece of real estate can be profitable.
If you rent out the property, you get rent money each month. Your mortgage payment stays the same but the money you collect in rent goes up over the years.
Real estate prices increase every year which means you can raise the rent as needed. Plus, as the years go by, the mortgage payment stays the same but the value of the property usually goes up.
The more property, the more money you’re gaining. It doesn’t matter if you flip a house or you rent out an apartment building. Your cash flow keeps increasing.
4. You Can Increase Your Savings
Having a savings account is important for financial emergencies. You never know what could come up.
Sometimes adding to your savings account can be difficult between all the bills and payments you have to pay from month to month.
When you pay off your mortgage early, you use extra money which could have gone into a savings account.
Instead of putting this money toward paying down your mortgage, you can invest in more real estate and make more money. Then, start saving.
5. You’ll Have a Diverse Portfolio
Owning more than one piece of property grows your portfolio. The more property you own, the more assets you have.
These assets can come in handy if something costly comes up quickly, like a medical emergency.
Plus, if you pay off your mortgage too early, you no longer have liquid assets to access in these types of emergencies. You can’t access that money without selling the property. It can take a long time to find a cash buyer or a buyer who’s been approved for a loan. Then, you have to wait to close the deal.
6. You’ll Have Asset Protection
Once you pay off the mortgage on your home or property, you lose that asset protection.
If you owe money to someone else and a creditor comes after you, they can take your property without a care in the world. But if you’re still paying off the mortgage, you don’t have to worry about losing the property.
Since you don’t own the home outright, a creditor can’t take it away from you.
There’s no right answer to the question of whether it’s better to pay off your mortgage early or to invest in more real estate. Make a list of the pros and cons and take the time to analyze your situation. Don’t jump into any decision right away.