Earning more than you spend is one of the “golden rules” of personal finance. This can be more challenging in the beginning stages of your career when you are in the wealth-building phase. But after working diligently for decades, you may have accumulated more money each month than you need. So now the question becomes, what’s the best way to use the extra income?

The main goal should be to put your money to work. Letting your extra income sit in a savings or checking account, where you earn less than a percent of interest, is not the wisest choice. The most common two options are either paying off your mortgage or investing. This can be a difficult decision for people to make as there are pros and cons to each. Here are some things to consider before deciding which option is right for you.

What Makes the Most Financial Sense?

When deciding between these two options, you first want to know which option can provide the greatest payoff. In this case, it’s your mortgage rate versus your expected investment return. You can calculate some rough estimates to evaluate which decision would make more financial sense.

Let’s consider an example. Say your mortgage interest rate is 5%. If you estimate that, based on your risk tolerance and time horizon, you can expect an investment return of 4%, it would make more sense to pay down your mortgage. Otherwise, you’re potentially throwing away 1%. However, if you are an aggressive investor and believe you could earn 8% on your investment, it would make more sense to invest.

This may sound simple on paper, but there are a lot of factors at play. And as we all know, even the best predictions aren’t set in stone. It’s essential to run a thorough analysis and factor in taxes on investments, mortgage interest deductions, risk, and private mortgage insurance, among other elements of your financial life. An experienced wealth advisor can run all of the calculations and do a complete analysis of your unique situation.

The Pros and Cons of Each Option

There are some pros and cons to each that go beyond the raw math. Liquidity is one big pro for investing. You’ll have easier access to it in case of an emergency. However, if you put the money towards your mortgage, it’s gone, for all intents and purposes. The only way to get the money back out is to sell your house or refinance your mortgage.

However, an advantage of paying down your mortgage is that your house will be paid off sooner. You will have a greater chance of being able to enter retirement without a mortgage, or at least have your mortgage paid off sooner during retirement. That way you can free up more of your money before your medical expenses start to build. If you invest, your mortgage will be another bill you have to pay while in retirement.

Another benefit of paying off your mortgage completely is decreasing your risk. Once you own your home free and clear, you never have to worry about foreclosure or having your credit damaged by missed mortgage payments. However, you still have to pay your taxes and carry some risk of having a lien placed against your property.

Choosing a Combination of the Two

For some people, it may make more sense to choose a combination of these two options. For example, if you have less than 20% equity in your property, you may be required to pay private mortgage insurance, meaning you owe additional premiums on top of your mortgage principal and interest payments.

In this case, even if your mortgage rate is 5% and you can earn 6% on an investment, you may still earn a higher return on your money by paying down your mortgage. Once you pay it down to at least 80%, you free yourself of needing private mortgage insurance and can start investing, should you determine that that’s a more appropriate option for you.

How We Can Help

While the general consensus is that paying off your mortgage is always the best idea, there are several other things to consider before making a decision and taking action. Hopefully this general overview has been helpful in your decision-making process.

At Cypress Wealth Services, our mission is to bring clarity and confidence to your financial life. Specializing in serving affluent families, we have worked with many clients facing decisions like this one. To learn more about how we can help you calculate the best return on your money in your specific situation, call us at 866.888.6563 or contact one of our offices today.

About Cypress Wealth Services

Cypress Wealth Services is an independent RIA firm providing financial planning and investment management to high-net-worth individuals, families, business owners, and institutions. Cypress Wealth Services comprises professionals with diverse backgrounds and extensive experience and qualifications. Cypress Wealth Services serves a broad range of client needs using their experience and expertise to act as a foundation for their client service process. The firm uses The Second Growth, which focuses on efficiently protecting, growing, and transferring the wealth and legacy a person has already built to their loved ones. With financial advisors in Palm Desert, CA, Tustin, CA, Athens, GA, and Anchorage, AK, the firm serves clients across the country with Wealth Management Services, Fiduciary Services, 401(k) Design, and Management, Investment Reporting Services, Financial and Retirement Planning, and more. For more information, visit www.CypressWS.com or call 760.834.7250.