Payoff Mortgage or Invest – The Complete Analysis

by Aug 29, 2020Personal Finance2 comments

Should I payoff the mortgage or invest?

A question every individual will ask and search in the google while in the journey of financial freedom.

A simple answer, several financial geeks provides is payoff mortgage if your savings rate or returns from investment is lower than mortgage interest rate.

In theory, this make sense. But, how would this help me to achieve financial freedom and retire early when I am still sitting on debt?

I thought, an analytical model will shed some lights to unfold the above question. And I believe this will help you make a decision on this complex question or situation.

Let’s explore how this analytical model works…

Payoff Mortgage or Invest: Assumption and Terms

In this article, I will explain the excel model I have developed to analyse and make a smart decision.

Warning! You will have to understand some financial terms and read through twice to digest the numbers and calculations used.

Firstly, below are the sheets, excel includes to support my analysis.

  • Mortgage_No Prepayment: This is a simple calculator of mortgage payments with no additional prepayments.
  • Mortgage_Extra Payments: This is again a simple calculator of mortgage payments but with some additional prepayments.
  • Investment Plan: This calculates the return you get on your investment in stock market over a period of 10 years or more. Here, I am assuming a conservative return of 6% year-over-year when invested in low cost tracker funds such as S&P 500. However, the historical data shows the year-over-year is in the 8% range.
  • Payoff Mortgage or Invest Analyser: An analytical tool to draw an analysis and support you make smart decisions.

Secondly, I will consider below scenarios in my analysis for different number of years such as 5, 7 and 10 years based on a mortgage loan of £235,000 with an interest of 2.04% and a tenure of 25 years.

  • Invest: In this scenario, you pay only scheduled mortgage. Invest the additional money you have in the stock market.
  • Payoff Mortgage: In this scenario, you will only pay scheduled mortgage with some additional prepayment. You invest no money in the stock market.
  • Invest & Payoff Mortgage: In this scenario, you make additional prepayment for the mortgage and equally, invest in stock market as well.

I am assuming your lender accepts atleast 10% of prepayment without any penalty.

Invest

In this scenario, let’s assume that you will invest £2000 in the stock market over 10 years. But, you will not make any additional prepayment towards mortgage.

Based on a 6% yoy return, let’s see what would be my financial stability over the years such as 5, 7 and 10 years.

Invest: 5 Years

Payoff mortgage or invest
  • Monthly Scheduled Mortgage Payment is £1001.
  • Monthly Investment of £2000 in stock market (Equity).
  • Total Invested is the total money invested in stock market for 5 years.
  • Total Mortgage Principal Paid is simply the total money paid towards the principal.
  • Interest: The total paid on a mortgage for 5 years.
  • Fee Paid is platform charges such as Fidelity charges 0.35% per year plus additional cost for tracker fund.
  • Total Equity is the total money in stock market including 6% return year-over-year.
  • Total debt: The outstanding balance to pay on the mortgage.
  • Net Equity is the same as Total Equity. In other words, it is the money in the stock market and can be easily converted into cash.
  • Net Debt is same Total Debt but a negative value.
  • Debt to Equity is equal to Total Equity minus Total Debt. In other words, your financial leverage.
  • Net Worth is total value of property and investment. It is calculated as Debt to Equity+(Total property value – Total Debt)+(Total property value x 5%).
    • I am assuming the property value will increase 1% every year. This mean at the end of 5 years, the property value would appreciate by 5% percentage.
    • I am assuming the property value as £300,000.
Payoff mortgage or invest
  • When you only invest £2000 for 5 years, you will have a Net Equity of £142,844.
  • You will have a Net Debt of £197,106.
  • You will have a negative Debt to Equity of £54,262.
  • Your Net Worth will be £63,631.

At the end of 5 years, your Net Equity would be almost half of your property value (£300K) which is good as this can be converted into cash easily.

But, the Net Debt is still too high and Debt to Equity is negative.

Your Net Worth (£63K) which is more than one fourth of property value (£300K).

Invest: 7 Years

  • When you only invest £2000 for 7 years, you will have a Net Equity of £212,750.
  • You will have a Net Debt of £180,816.
  • You will have a negative Debt to Equity of £31,933.
  • Your Net Worth will be £181,117.

At the end of 7 years, your Net Equity (£212K) would be more than half of your property value (£300K).

The Net Debt is still negative but reduced to 70% of mortgage value (£235K).

Debt to Equity is less than one fourth of your property value (£300K).

Your Net Worth (£181K) which is more than half of your original property value (£300K).

Overall, your financial stability will be better compared to 5 years if you continue to invest for 7 years.

Let’s see what would be your financial stability if you continue to invest for 10 years…

Invest: 10 Years

Payoff mortgage or invest
Payoff mortgage or invest
  • When you only invest £2000 for 10 years, you will have a Net Equity of £333,743.
  • You will have a Net Debt of £155,102.
  • You will have a negative Debt to Equity of £178,641.
  • Your Net Worth will be £353,539.

At the end of 10 years, your Net Equity (£333K) would be more than your property value (£300K).

The Net Debt (£155K) is still negative but reduced to approx. 60% of mortgage value (£235K).

Debt to Equity (178K) is more than half of your original property value (£300K).

Your Net Worth (£353K) which is more than your original property value.

Overall, your financial stability will be lot better compared to 5 and 7 years if you continue to invest for 10 years.

Let’s see what would be the case if you choose to payoff mortgage rather invest…

Payoff Mortgage

In this scenario, let’s assume that you will repay £2000 each month towards mortgage over 10 years on top of your scheduled mortgage payment of £1001. But, you will not invest in stock market.

Based on only prepaying mortgage, let’s see what would be your financial stability over the years such as 5, 7 and 10 years.

Payoff Mortgage: 5 Years

Payoff mortgage or invest
  • In 5 years, your Net Equity is £0.
  • You will have a Net Debt of £70,885.
  • You will have a negative Debt to Equity of £70,885.
  • Your Net Worth will be a negative value of £173,229.

At the end of 5 years, your Net Equity would be £0 as you have not invested in stock market.

The Net Debt (£70K) is still negative but reduced to approx.30% of mortgage value (£235K).

Debt to Equity (£70K) is negative.

Your Net Worth (£173K) which is more than half of your original property value (£300K).

Your Net Worth will be better compared to investing (Net Worth: 63K) for 5 years. However, your equity or cash will be poor as Debt to Equity is negative and Equity is zero.

Overall, at end of 5 years, all your capital is invested on property and that makes you financially less leverage.

Let’s see what would be financial stability you continue to payoff mortgage for 7 years…

Payoff Mortgage: 7 Years

Payoff mortgage or invest
Payoff mortgage or invest
  • In 7 years, your Net Equity is £0.
  • You will have a Net Debt of £394. Almost, Debt Free.
  • You will have a negative Debt to Equity of £394.
  • Your Net Worth will be a negative value of £320,212.

At the end of 7 years, your Net Equity would be £0 as you have not invested in stock market.

The Net Debt (£394) is very low. Congratulation! You are almost become debt free.

Debt to Equity (£394) is still negative.

Your Net Worth (£320K) which is more than your original property value (£300K).

You become Debt Free. So, can you retire now?

If I was you, I won’t retire because the equity or cash is still poor as Debt to Equity is negative and Equity is zero, unless I have another source of income to survive for rest of my life after retirement.

Overall, at end of 7 years, still all your capital invested on property and that makes you financially less leverage.

Since, the mortgage is paid off, you free up the money (£3000), which you used to pay mortgage. Let’s assume you will invest this money for next 3 years.

Let’s see if you invest for 3 year after payoff mortgage (i.e. after 7 years) helps you to retire by end of 10 years.

Payoff Mortgage: 10 Years

  • In 10 years, your Net Equity is £121,486.
  • Your Net Debt is £0. You are Debt Free.
  • You will have a Debt to Equity of £121,486.
  • Your Net Worth will be £451,486.

At the end of 10 years, your Net Equity would be £121K based on 6% yoy from stock market for up to three years.

You are debt free and Debt to Equity is £121K.

Your Net Worth (£451K) which is better and provides some financial leverage as equity or cash (£121K) is positive.

Overall, at end of 10 years, although most of your capital is invested in property, you still have some equity that gives you slightly more financial leverage.

So, can you retire now?

It depends. Even though you have Equity of £121K and draw money each year from your Equity for you living.

But, will that last for the rest of your life after retirement?

It depends on your expected monthly expenses and your retirement number calculated as part of retirement planning.

Read more to learn about retirement number and retirement planning.

Let’s see what would be the case if you choose payoff mortgage rather invest…

Invest and Payoff Mortgage

In this scenario, let’s assume that you will invest £1000 in the stock market over 10 years. You will also make equal money (£1000) as prepayment towards mortgage.

Invest and Payoff Mortgage: 5 Years

  • In 5 years, your Net Equity is £79,310.
  • You will have a Net Debt of £133,996.
  • You will have a negative Debt to Equity of £54,686.
  • Your Net Worth will be £126,319.

At the end of 5 years, your Net Equity would be more than one fourth of your property value (£300K) which is good as this can be converted into cash easily.

But, the Net Debt is still too high and Debt to Equity is negative.

Your Net Worth (£126K) which is slightly less than 50% of property value (£300K).

Invest and Payoff Mortgage: 7 Years

Payoff mortgage or invest
  • In 7 years, your Net Equity is £115,199.
  • You will have a Net Debt of £90,605.
  • You will have a negative Debt to Equity of £24,594.
  • Your Net Worth will be £254,989.

At the end of 7 years, your Net Equity (£115K) would be 40% of your property value (£300K).

The Net Debt is still negative but reduced to 40% of mortgage value (£235K).

Debt to Equity is not high but a positive value.

Your Net Worth (£254K) is more 80% of your original property value (£300K).

Overall, your financial stability will be better compared to five years if you continue to Invest & Payoff mortgage equally for 7 years.

Let’s see what would be financial stability if you continue to Invest & Payoff mortgage for 10 years…

Invest and Payoff Mortgage: 10 Years

Payoff mortgage or invest
  • In 10 years, your Net Equity is £177,559.
  • You will have a Net Debt of £22,111.
  • You will have a Debt to Equity of £155,448.
  • Your Net Worth will be £463,337.

At the end of 10 years, your Net Equity (£177K) would be 40% of your property value (£300K).

The Net Debt is still negative but reduced to less than 10% of mortgage value (£235K). It will take another one year to be debt free if you continue to prepay on top of scheduled mortgage payment.

Debt to Equity is not high but a positive value.

Your Net Worth (£254K) is more 80% of your original property value (£300K).

Overall, your financial stability will be lot better compared to 5 and 7 years if you continue to Invest & Payoff mortgage equally for 10 years.

Comparison of Different Scenarios

Let’s compare the three scenarios of each years such 5, 7 and 10 years.

Comparison: 5 Year

If you choose to Invest only, the Net Equity is higher but your Net Worth will be lower compared to all other scenarios. At the same time, the Net Debt is higher. As a result, your Net Equity and Net Debt will be the same which leaves you with negative Debt to Equity. This is not the best option to choose for 5 year plan.

If you choose to Payoff mortgage rather invest, your Net Equity will be zero and Debt to Equity will be negative. But your Net Debt is low and Net worth is higher. As a result, your Net Debt is 50% of mortgage value. However, your Net Equity will be Zero so this is not the best scenario to choose.

If you choose to Invest and Payoff mortgage, your Net Equity, Net Debt, Debt to Equity and Net Worth stands in between the other two scenarios.

As a result, your financial stability is slightly better compared to other two scenarios. Because, your Net Debt is slightly less than 60% of your mortgage.

Your Net Equity and Net Worth is also higher than Invest only Scenario and slightly lower than Payoff Mortgage only scenario.

Comparison: 7 Year

If you choose to Invest only, the Net Equity is higher compared to other scenarios. But, your Net Worth will be lower. At the same time, the Net Debt is higher.

As a result, your Net Equity and Net Debt will be the same which leaves you with less Debt to Equity.

If you choose to Payoff mortgage rather invest, your Net Equity and Debt to Equity will be zero. But your Net Debt is very low and you are almost debt free. Net worth is higher as well. But again your Net Equity will be Zero.

This is not the best scenario to choose as your capital invested only in property. It is not easy and quick to convert your property into cash when required.

If you choose to Invest and Payoff mortgage, Net Equity, Net Debt, Debt to Equity and Net Worth again stands in between the other two scenarios.

As a result, your financial stability is better as your Net Debt is less than 50% of your mortgage. Your Net Equity and Net Worth is also higher than Invest only Scenario and slightly lower than Payoff Mortgage only scenario.

Comparison: 10 Year

If you choose to Invest only, the Net Equity is much higher compared to other scenarios. But, your Net Worth will be lower.

At the same time, the Net Debt is higher (still more than 50% of mortgage value) if you invest only. As a result, your Net Equity and Net Worth will be almost same which leaves you with a high Debt to Equity.

If you choose to Payoff mortgage and invest thereafter (for 3 years), you will become debt free. Net worth is higher as well.

But again your Net Equity will still be low and may not be sufficient enough to support early retirement. Most of your capital invested only in the property. This is not the best scenario to choose even for 10 years plan.

If you choose to Invest and Payoff mortgage, your Net Debt is very low and you can become debt free in another one year. Net Equity and Debt to Equity will be almost same.

Net Worth is higher compared to other two scenarios. As a result, your financial stability is lot better as your Net Debt is less than 10% of your mortgage. This seems to be the best option to choose.

To sum up the analysis, maths clearly shows the investing in stock market gives your great financial leverage due to high Equity.

As financial geeks suggest to invest when mortgage rate is lower than savings rate or return of investment, seems to the better option.

Equally Investing and Payoff Mortgage in 10 years, provides you higher Net Worth and Equity is also comparatively good.

Conclusion: Should You Payoff Mortgage or Invest?

Although, investing is rewarding and historical data shows returns in the 8% range.

The risk is still higher and the problem is past performance no guarantee of future returns. Nobody has a crystal ball with any return comparison.

Life usually doesn’t go as expected. We are not computers which has programming language and who implement our excellent plans with mathematical precision.

Life throws obstacles in our way, plans may change, unexpected happens, and that’s just the way life works.

Payoff Mortgage only increases your Net Worth and provides your emotional return. However, you do not want to invest capital only in property, that makes less financial leverage and less diverse portfolio .

Why not do both?

Analysis also shows that equally invest & payoff mortgage rewards more with high Net Worth and Net Equity as well. With this, you will become debt free and have high financial leverage.

You may possibly semi-retire or completely retire early based on your retirement number.

In summary, you should be fine with dedicating a portion of my income toward paying off the mortgage and investing to reduce debt while accumulating equity.

The logic is you get more emotional return by becoming debt free when compared to high investment returns with a risk element.

I realise this analysis has lot of assumptions made around the money you prepay mortgage and invest. Your mortgage value, interest rate, and tenure may also vary.

You can run this analysis yourself by plugging in your real numbers in Payoff Mortgage or Invest Analyser.

How has this analysis helped you make the decision and what conclusion did you attain? Please share in the comments below…

Related Books to Read

  • Intelligent Investor: The Definitive Book on Value Investing. Buy on Amazon.
  • The Financial Times Guide to Investing:The Definitive Companion to Investment and the Financial Markets: The Definitive Companion to Investment and the Financial Markets. Buy on Amazon.
  • One Up On Wall Street. Buy on Amazon.
  • Overcoming Underearning: A Five-Step Plan to a Richer Life. Buy on Amazon.

Disclaimer and Disclosure

The content in this page is the opinion of the author and is for informational purposes only. Any content should not be interpreted as “advice”. This website make no representations as to the completeness, suitability, accuracy or validity of any information and will not be liable for any errors or omissions or any damages arising from its display or use.

Some of the links above are affiliate links, meaning not cost additional cost to you, I will earn a commission if you click through and make a purchase.

About Me

My name is Naresh Jayakumar. I am mastering personal finance to effectively manage, save and grow money. I’m on my happy jounery to financial indenpendence.

I blog to share the tricks and hacks of making, managing and saving money to help others achieve Financial Independence in their lives too.

 

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2 Comments

  1. Gentleman's Family Finances

    Very thorough post and it’s obvious that you put a lot of effort into it.
    Some minor comments would be a question of whether a mortgage at 2.04% at 90% ltv and invest the rest is better than an 80% ltv at 1.54% and so on.
    Marginal borrowing costs used to be in excess of 10% but are now a lot flatter at about 6% – putting things in the “invest” camp.

    Secondly – invest in your pension and pay off your mortgage with the 25% tax free lump sum – it makes the choice rather obvious (although you do take the risk of high debt with you until you hit 58 and can get that money.

    • Naresh Jayakumar

      Thanks for reading:)
      80% ltv (£240K) at 1.54% would saves you approx.£25K in interest. 2.04% at 90% ltv (£270K) and investing the rest (£30K) for 10 years may earns you £53K based on flat 6% yoy returns. Returns is double than the savings in interest rate. Again return from equity is no guaranteed. This choice is based on our tolerance to risk element.

      Ofcourse, investing in pension is good and some employers match employees pension contribution and we should take advantage of it.

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