Question:

Mortgage prepayment vs. investment: which is better?

Answer:

This is a question that has no exact right or wrong answer. It depends on a number of factors whether you should use your money to prepay your mortgage or use it to invest somewhere else. Here are some factors that need to be considered before taking a decision:

Mortgage Interest Rate and Investment Rate of Return:

The biggest factor on any investment is return. You should compare the rate of return on your investment to the interest rate of your mortgage. The higher one gives you better use of the money. Usually investments provide higher rates than mortgages, but before you decide to invest you should look at some other factors as well.

Taxes and Exemptions:

Whatever you earn on your investment might be subject to taxes as per the federal/state law. This in essence reduces the rate of return on the investment. Conversely, in some cases the deductibility of mortgage interest reduces the overall tax bill and you may want to hold onto the mortgage while investing your money elsewhere.

Risk on Investment:

Investing your money for high return would involve some sort of risk, whereas, mortgages guarantee their returns by making you owner of the house after prepayment of the loan.

Homeowner's Age and Risk Aversion:

The age of the homeowner can play a big part in the decision whether to invest or to prepay the mortgage. Older people at the end of mortgage periods are not paying a lot of interest in their monthly mortgage payments hence they do not have much tax exemption while younger people face the opposite scenario. This means that it is more beneficial for older people to pay off their mortgage early. Also, older people have greater risk aversion than younger people and would probably not want to invest in a risky market.

Prepayment Penalties:

Prepayments are often discouraged by lenders because they do not want borrowers to get out of the loan deal before the originally agreed upon term as it hurts their portfolio. Therefore if you want to prepay a mortgage, make sure that you have factored in the prepayment penalty cash outflow.

Careful consideration of these factors should help you decide which option would suit you best.

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