Being someone who helps Pharma employees improve their finances I tend to get a lot of the same questions from people over and over again.
Some are easier to answer then others.
When can I retire? – it depends.
How much insurance should I have? - it depends.
How do you feel about the stock market? - let me grab my crystal ball.
But there’s one very common question that has always been really straight forward, at least until recently.
Should I put extra money towards my mortgage?
For the first decade or so of my career when I’ve gotten that question, 99% of the time the answer has been “absolutely not”.
After all until recently we have been living in one of the lowest interest rate periods in history, and most people had either bought their home, or refinanced during this time.
Most people I’d talk with would have a mortgage sitting in the 3-4% range. Historically speaking that’s pretty low, and it’s pretty cheap debt.
Putting Your Money to Work
Here’s the thing about paying down low interest rate debt. The question you really have to ask yourself is, is this the best use of my money?
Let’s say you have a 30 year mortgage with a 3% interest rate and an extra $100 per month.
You can put it towards the mortgage; maybe pay it off a few years earlier than expected. That helps your future cash flow, and gives you some piece of mind. Maybe that’s all you really want and if that’s the case great – go for it.
But consider the alternative, in the last 30 years, from 1993 to 2023, the S&P 500 has averaged just under 10% return each year.
Investing $1,200/year over 30 years with a 10% annual return would result in quite a bit of money – just over $197,000.
That's likely more than you'd end up with if you were just paying off the mortgage early.
No obviously that 10% return isn’t guaranteed and you’d need to have a balanced investment strategy that you’re comfortable with.
But that's the beauty of the low interest rate - you don’t need to earn 10% for this to make sense.
You just need to beat your interest rate, in this example you would have to earn more than the 3% interest rate that you’re paying.
If that happens you’re in the green.
And since 3% is a pretty low rate it shouldn’t be to unrealistic that you could average a higher investment return over a 30 year period.
Things Have Changed A Lot
That brings me to my problem with this question today.
In case you haven’t noticed interest rates have skyrocketed, and there’s no signs that we’ll be back to 3% mortgage rates any time soon.
The Fed’s fund rate went from .25% in early 2022 to 4.5% currently.
That’s a massive increase and as a result new mortgages are sitting up in the 6% range.
That means it would be so much harder to out-earn your interest payments by investing elsewhere.
If you’ve unfortunately found yourself buying a house in today’s interest rate environment and you’re wondering if you should put extra money towards the mortgage – now I’d say maybe.
You still want to make sure you’re covering the other financial areas of your life, such as emergency funds, insurance, and your retirement and work benefits.
But assuming you’ve got everything else covered, and you’ve still got cash flow to spare it might not hurt to put a bit extra to paying off the mortgage earlier.
But it’s really not as much of a clear-cut answer as it was previously.
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