Should I pay off my mortgage or invest more money?

Managing money can be rewarding as you watch your finances improve with time and work. As your income rises and debts decrease, you'll have more money to work with in your budget. 

At that point, you might ask, "Should I pay off my mortgage with this extra money?" After all, there are other things you could do with the money, including investing it. Investing is almost always wise, even when you're young and raising a family, but paying off your mortgage might be the better choice. It all depends on your personal situation.

Let's dig into these options to see if paying off your mortgage early is the best choice for your family. 

What is a mortgage?

Should I pay off my mortgage early? As you contemplate this question, it's helpful to understand what a mortgage is. A mortgage is a loan you use to purchase a home. Most home loans last 30 years and require equal monthly payments for 360 months. The amount you borrow is called the principal balance. When you make your last payment, your principal balance is $0, and you own the home. 

With a mortgage, you'll pay interest. This is the money the lender makes from issuing you the loan. So your monthly mortgage payments include principal and interest. At first, your payments will primarily go toward the interest. As you pay down the principal balance, you'll pay less interest, which accumulates only on the amount you owe. Most people get mortgages to buy homes because saving up enough cash for a house takes a long time. For many, it’s easier to buy a house with a loan and repay the money over the next 30 years. 

Types of mortgages

Mortgages come in all shapes and sizes, which means there are different types. Here are some of the types you can get:

• Conventional loans: These loans require a higher credit score, a lower debt-to-income ratio (DTI), and usually a higher down payment than other loans. However, you can qualify for a conventional loan with as little as 3% down. These loans aren't backed by a government entity. 

• FHA loans: The Federal Housing Administration backs these loans. Many people use them to buy homes when they don't meet the credit score and down payment requirements for conventional private loans. You need only 3.5% down for an FHA loan.

• VA loans: These loans are ideal if you have military experience. You won't need a large down payment or a high credit score to qualify. In fact, you might qualify for a VA loan with 0% down.

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These are just a few types of loans, but there are others. Loans also come with two types of interest rates: fixed and variable. A fixed rate never changes for the entire loan duration, while a variable rate changes after a specified number of years. 

Benefits of paying off your mortgage early

If you're like most people, you'll get a 30-year mortgage. You can look at your loan documents to see the date of your final payment. Seeing this date might blow your mind. Thirty years is a long time from now! But many people pay off their mortgages early, and you can, too. It probably won't surprise you that paying your mortgage off early can be highly beneficial. Here are a few benefits to consider:

• You'll own your home outright faster.

• You'll instantly reduce your monthly expenses.

• You'll save money on interest.

Imagine what you could do with the extra money each month if you were to no longer have a mortgage payment. 

Before you rush into this decision, read through your loan documents. Do they say anything about paying a prepayment penalty? If so, this means you'll pay a fee if you pay off your mortgage early. Find out the fee amount to see if it's worthwhile before paying your loan off early. 

Options for paying off your mortgage

So what's the best way to pay off your mortgage early? There are two primary ways.

Refinancing your mortgage

First, you could refinance your mortgage. This simply means that you get a new mortgage loan, which pays off your current one. This option doesn't get you out of debt but might help you acquire better loan terms. For example, you might refinance if you can get a lower interest rate. That alone can help you save thousands of dollars. 

However, you can also refinance to shorten your loan. Suppose you took a 30-year mortgage loan five years ago. You’ve paid on it for five years, so you still have 25 years to go. If you refinance to a 15-year loan, you’ll go from 25 years of payments to only 15. This means you'll instantly knock off 10 years of loan payments.

Increasing monthly payments to principal 

The other option is to increase your monthly payments by paying extra each month. The extra money you pay applies to your principal balance, helping you pay it off faster. 

Consider this: If you make one extra payment each year on a 30-year loan, you'll cut off five years of payments. Instead of paying your loan off in 30 years, you'll own the home outright in only 25. That's just from one extra mortgage payment a year! Use a mortgage calculator to play around with the numbers. Then, make a plan to start paying extra. 

Tips for budgeting to pay off your mortgage early

Paying off your mortgage early can give you financial freedom faster. Here are some helpful ideas that might help you pay yours off faster:

• Round up your payments to the nearest $100 every month.

• Apply your tax refund money to your principal balance each year.

• Increase your mortgage payments by a specific amount each month.

• Reduce your other monthly expenses to free up cash for your mortgage payments.

• Apply windfalls of money to your mortgage balance whenever you receive them.

Talk to your family about your budget and goals. Include them in finding creative ways to save money, and explain to your kids the benefits of paying off your mortgage early. Introduce them to the Greenlight Level Up financial literacy game. It's a fun game that teaches kids and teens about financial literacy. You might even learn a thing or two if you play it with them!

Risks associated with mortgages and refinancing

Are you asking, "Should I pay off my mortgage or invest?" If so, compare the difference between how much you'd earn from investing vs. how much you're spending on mortgage interest. Can you earn more through investing than the amount you spend on your mortgage interest? If so, investing might be a good option. In addition, think about the risks you assume with a mortgage vs. the risks associated with your investment options. 

What are the risks of taking out a loan?

You inherit risks with a mortgage. One risk is losing money. If you suffer hard financial times and can't make your payments, the lender can take your home. You'll not only lose the house, but you'll also lose the money you invested in it. This is a major risk you take on when you have a mortgage. 

Secondly, you take the risk of an increased interest rate if you have an adjustable-rate mortgage (ARM). If interest rates rise, your rate could significantly increase. The result is higher mortgage payments and more money spent on interest over the life of the loan. 

The risks of refinancing

Refinancing is also risky at times. What if you refinance to cut off 10 years of payments and then lose your job? You'll have higher payments and no income, which might put you in a scary financial situation. Refinancing is also costly, which can set you back. Instead, you can pay extra on your monthly payments. You'll achieve the same goal without spending money on refinancing costs. 

Choose the alternative option: Investing your extra money!

We’ve talked a lot about the benefits of using your extra money to pay off your mortgage early. But we haven’t discussed the benefits of the alternative: investing the money. Investing is a process that helps you earn money with your money. And there’s no one-size-fits-all approach; you can do it in many ways.

One option is buying stocks, bonds, or mutual funds. You might find some great investment opportunities that look promising. If you put some money into those, you might earn a high return without any effort. This would be a worthwhile reason to buy the investments.

Another option is investing in a business. Maybe you have a unique idea for a business and can earn a high return from putting your money there instead of toward your mortgage balance. This idea might return a steady income year after year; plus, you could end up with a highly valuable business to sell if you ever get tired of owning it. 

There are pros and cons to investing instead of paying off your mortgage. One of the benefits is that you’ll grow your savings and investment accounts, leaving you with more money for emergencies, retirement, and other purposes. The downside is that it will take you longer to pay off your mortgage, causing you to pay more in interest over the course of the loan.

Paying off a mortgage early might help your family reach financial freedom faster

You can take your extra money and invest it or pay off your mortgage early. Consider both options and choose the best one for your family’s financial future. Learn more about mortgages, debt, and other financial topics in Greenlight’s Learning Center!