Do you prioritize debt or investments?
This is a common questions in personal finance, with debt positioned as investment’s evil twin. While your investments grow and make you steadily wealthier, growing debt can make you steadily poorer. You want to hold investments for as long as possible. You want to pay off debt as quickly as you can. But these two goals are often conflicting.
So here’s the question. If you have $75,000 remaining on a mortgage and $250,000 in an IRA, should you pull money out of your portfolio to pay off that mortgage, or prioritize your investments? The odds are that you should keep this money invested, but it can depend on a number of factors.
Here are a few things to consider. And remember, you can talk to a financial advisor to create a personalized financial strategy for retirement.
Compare Opportunity Costs of Debt vs. Investment
You need to consider the interest rate of your mortgage vs. the average return on your IRA. Which is growing faster? This is particularly important because, thanks to compound growth, your IRA has a built-in advantage. The growth on the $250,000 account will net more dollars at the end of the day, compared to the interest lost on an outstanding $75,000 mortgage, even at the same interest rates.
For example, a the current 30 year fixed-rate mortgage has a 7.76% interest rate. At that rate, if you left it alone, in 10 years such a new mortgage would have cost over $55,000 in mortgage interest. At that same 7.76%, over the same 10 years, your $250,000 IRA would grow to $527,856.
In this hypothetical case, your IRA would grow three times more quickly than the mortgage debt (gaining more than $270,000 in value compared to the mortgage gaining about $83,000).
Of course, your accounts won’t grow in a vacuum. This decision will depend on how much you would pay in mortgage interest vs. how much you would gain in account value. This will depend on:
- The interest rate on your loan
- The original principal
- Years remaining of repayment
At the end of the day, you have a high likelihood of coming out ahead by continuing to pay your mortgage normally and letting your IRA grow untouched. While you might feel anxious about having a mortgage payment left when you retire, you’ll also want to consider your Social Security payments as part of the equation. You’ll want to consider your risk tolerance too, as your personal comfort with risk may play into making the best choice for your financial house.
A financial advisor can help you weigh the tradeoffs between different paths.
Should you prioritize paying off your mortgage or staying invested? While there are many factors to consider here, perhaps the most important issue is opportunity cost. Particularly if your mortgage close to repayment, the odds are good that your portfolio will grow much faster than your debt, so paying off that mortgage can mean missing out on real growth.
- Another important issue here is whether your mortgage rate is fixed or variable. If your mortgage will keep getting more expensive as rates rise, that’s known as a variable interest rate, and it might change the math on repayment altogether.
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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