Making a decision of whether to overpay your mortgage or invest can be tough. This is especially true for those aiming for financial independence and early retirement (FIRE). Financial independence means freedom, but can you be truly free while having a mortgage?
There is a lot of unclarity surrounding the question of whether you should overpay your mortgage or invest. And there is a reason for this. The answer is not straightforward and depends upon a multitude of factors.
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Should you overpay your mortgage or invest for FIRE?
First of all, before thinking about overpaying your mortgage or investing your money, you should create an emergency fund. This will protect you in case of emergencies, for example if you lose your job or become ill.
Typically, an emergency fund should cover your living expenses for three to six months. If your income is very variable, you may want to save up to 12 months’ worth of living expenses in your emergency fund.
Another point to consider is any other debt you may have. Unless it is interest free, you should pay off any other debt before overpaying your mortgage or investing.
This is because in the vast majority of cases the interest on your debt is higher than any return from investing or overpaying your mortgage. Plus, having debt is always associated with risk. If something unforeseen happens and you cannot make minimum payments on your debt, you would have to take money out of your investment account at a bad time.
Overpaying versus investing
Whether you should overpay your mortgage or invest is a tricky question. There is no right or wrong answer and one size does not fit all. However, here are some factors you may wish to consider:
Looking at the issue from a purely financial perspective, investing almost always outperforms overpaying your mortgage. Assuming your money is sensibly invested in an index tracker, you can expect a 7% growth per year.
Note that these 7% are an average value. In some years, your fund may grow 20%, but in others it may fall by -20%. Investing is a long-term game, and you should be prepared to leave your money in the market for five to ten years.
On the other hand, your mortgage interest is likely to be less than 7%. Interest rates vary and depend on many factors. Assuming you are paying 3.5% interest on your mortgage, you would, over time, gain an advantage by investing. Note that this may not be immediately apparent.
Additionally, investing money in the stock market comes with the benefit that the money is more liquid than if you had overpaid your mortgage. This is because selling stocks is easy compared to releasing equity from your house. Although selling stocks at the wrong time may come with a penalty, it can be useful during an emergency.
Apart from the most financially sensible course of action, you should also take into account psychological factors. Owning your house can give you a feeling of safety and security. By paying your mortgage off sooner, you are reducing the total amount of debt you have. Some people find it depressing owing a vast sum of money to the bank.
Additionally, living in a home you own versus living in a home that is owned mostly by the bank can feel differently. For some people, these fine details hardly matter. For others, they mean a difference like night and day.
Neither of these viewpoints is right or wrong. You only have one life so you should do what makes you feel most comfortable. Being stressed out and worried can have detrimental effects on your life that are much worse than the small amount of money you lose by overpaying your mortgage versus investing.
Time to financial independence
Time to financial independence is less important but nonetheless a point you may want to consider. It is worth keeping in mind that just paying off your mortgage will not make you financially independent. You will still have to cover the costs of all other life aspects.
There are different scenarios to consider:
- You want to be financially independent before paying off your mortgage
- You want to be financially independent after paying off your mortgage
Thus, your approach may be influenced by your time to financial independence. If you want to reach financial Independence after you paid off your mortgage, overpaying is the right choice.
If you want to retire earlier, investing your money is a more sensible decision. This means you can live from your funds and pay your mortgage from the growth of your stocks.
Should you overpay your mortgage or invest for FIRE? summary
The question of whether to overpay your mortgage or invest is not easy to answer. This post provides you with important points you may wish to consider, such as:
- Financial factors
- Psychological factors
- Time to financial independence
However, ultimately, the decision is yours to make and you should do whatever you feel most comfortable with.
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