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Money is tight for a lot of people right now, thanks to ongoing inflation and a volatile economy in the wake of the COVID-19 pandemic. It might seem logical to put any extra money you have toward a long-term investing strategy, as your gains could outpace inflation. The S&P 500 gained value in 40 out of the last 50 years, returning an average annualized return of 9.4%, after all.
But finance guru, author, and podcast host Suze Orman has a different take on the question of what to do with extra cash. She recently tackled a listener question on her podcast about whether an extra $10,000 per year is better applied to pay down a $400,000 mortgage loan with an interest rate of 3% or to guaranteed return investments like Treasury bills or a certificate of deposit (CD) with an interest rate of 5%. Orman is a noted fan of Treasuries, and so you might expect her to advocate for them in this instance. You’d be wrong, though.
How do mortgage loans work?
Orman noted that mortgage loans are structured so they’re front-loaded with interest payments (meaning that at the beginning of your loan term, you’ll pay more in interest than you will on the principal balance of the loan). In this way, they’re designed so that the mortgage lender makes more money off you in interest even if you decide to sell the home ahead of paying off the mortgage. You can check out your amortization schedule to see how much your payment goes toward interest versus principal.
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Based on the math involved, the listener might be able to pay off their mortgage loan in 15 or 16 years (rather than 30 years) by paying $10,000 more into it per year. So they would own the home faster — but miss out on gains from investing over that same period of time. Why didn’t Orman insist that investing that money was the better choice?
The reason is psychological, emotional, and personal
Orman is always outspoken about the need for women to take care of themselves financially. The name of her podcast is Women & Money! While she acknowledged the financial variables (both known and unknown) in this particular situation, she also noted, “I know that nothing makes a woman in particular feel more secure than owning her home outright.”
So she advised the listener to consider how they would feel if they knew their home was paid for, and if something happened (such as a life-changing event that made them have to quit working, for example), they wouldn’t lose their home. As Orman also said, “The goal of money is to make you feel secure.”
What should you do in this situation?
If you are fortunate enough to have extra money coming in and wonder whether it’s better to invest or pay down your mortgage loan, there’s a few things to consider beyond just the psychological impact of having a paid-off home (which is significant).
If you’re not planning to stay in the house forever and think you’ll sell in a few years, it’s perhaps a better move to just make your mortgage payments like normal and invest the extra money. You should also consider your ability to actually invest the money and leave it be, rather than panicking and selling your investments (or cashing out your CD account when the term is up and not opening a new one). Consider your future plans and investing style when making such a decision for yourself.
But definitely don’t discount that feeling of security mentioned by Orman. The peace of mind that comes from knowing your home is paid for could be worth the lost investment gains on extra money.
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