Do you put extra money toward principle or invest that money elsewhere?

Question

I've had a conundrum the last few years since I bought my first primary residence, I was lucky to get a good interest rate <5% When I purchased this property I was very green and new to real estate but I had heard or seen somewhere on some financial blog or podcast that if you pay an extra $100/mo toward your mortgage in many cases you can accelerate your payoff date 5+ years. Obviously this depends on the amount of your loan, when you start to pay the extra amount, etc. But I did the math and for me personally that was true, I'd pay off my mortgage 5 years early if I paid an additional $100 each month to principle.

At the time I purchased this condo, I was in my early 20's and the idea of signing a document that committed me to anything for 30 years freaked me out, because I hadn't even been alive for 30 years! The thought of making that a 25 year commitment instead gave me a slight feeling of safety so right away I started paying an extra $100 in principle to my mortgage every month.

It's been 6 years and I finally realized, maybe I could be putting this money to better work elsewhere? My interest rate is sub-five percent so I could be earning more money on that $100 than I'm spending to keep it in the loan. The emotional attachment to the idea of paying off my mortgage early still looms large in my brain though. So I made a compromise with myself, instead of putting that $100 directly to my principle, I'm opening a brokerage account that will have $100 deposited into it automatically every month and invested in index funds using dollar cost averaging method. This way I have more flexibility with what I want to do with my money, and if I keep it up for another 20 years, who knows, maybe I'll be able to use it to pay off my mortgage as a lump sum at a later date if I choose to do so. And by investing it somewhere it hopefully grows more than 5% per year- I have the possibility of having enough to pay off the mortgage even sooner than my original 25 year timeline.

What do you think? Do you pay any extra toward principle of your primary or buy-and-hold rentals? Do you take all your cashflow and stick it into your reserves? Do you invest that cashflow in an asset other than real estate? Or maybe your cashflow is just helping you fund your life right now! Let me know what you're doing and why!

Nathan Gesner · Answer

Your focus should be on expansion until you reach your final goal numbers (if ever). Once you hit those numbers, then you can focus on putting extra income towards paying down principal. Pay off the smallest loan first, then work your way up to the largest. It starts slow, then snowballs.It's important to understand the power of leverage. I like the Unofficial Guide to Real Estate Investing. Here's a fundamental explanation to get your juices flowing: Assume a house costs $200,000 and rents for $1,500. The market appreciates 3% per year. Pay cash for one house and rent it for $1,500. After five years you'll have earned $90,000 in rent income and gained $34,000 in appreciation. Buy four houses with $50,000 down on each. The mortgage payment is $1,000 on each house, so you earn $500 per house or $2,000 monthly. After five years, you'll earn $120,000 in rent income and $136,000 in appreciation. You've earned $132,000 more by splitting your money and leveraging it.The real key is setting your goals. If you don't know what you are trying achieve, specifically, then you will never figure out how to get there.

Alecia Loveless · Answer

@Rene Hosman I have been attempting to pay off extra on my mortgages every month. A few weeks ago I had a meeting with a mentor and asked his opinion about this. He is a commercial real estate developer as well as having built and owned several multi million dollar businesses and has owned residential rental properties as well. He explained that as a fairly new investor, 5 years, that if he was in my position he would save the extra funds for his emergency fund or eventually use the accumulated extra money to buy his next investment. He explained that since my loans were fairly low interest like yours that the money could be better deployed elsewhere to generate a higher than 5% return I was getting by paying off the loan early. This resonated with me and I have stopped the early payoff in lieu of increasing my reserves. What makes the most sense to you may vary, and may also depend on how risk averse you are. And like you said if getting that balance down below a 25 year commitment is most important to you then by all means keep paying the extra $100.

Theresa Harris · Answer

Honestly it comes down to what your goals are and what works best for you. If I had a high interest rate and wasn't planning on buying more properties, I'd probably pay down my mortgage faster. If my mortgage rate was low and I was saving to buy another property, I wouldn't pay it down. As others mentioned, look at what other debt you have and make sure the highest interest debt is paid off first.In a perfect world, you'd figure out where your money would make the biggest bang (ie the most money) and put it there whether that was a paying down a mortgage or investing in something else.

Cliff Benner · Answer

I feel for a mortgage it is better to pay the minimums, as long as that interest rate is low. I would pay off everything else first; credit cards, car loan, personal loan, college loans. There are so many things that you could put extra money towards that will compound more now and grow into something bigger than paying off your mortgage early. I would say what you are doing now with the investment fund is great, then find a real estate deal or a business to use that amount in the fund to purchase and repeat, and/or max your HSA out first.

Rene Hosman · Answer

Thanks for sharing Alecia! Luckily even with the extra $100 toward principle the last few years I was able to build up reserves that I'm comfortable with but as soon as money has to come out of reserves I'm sure I will use the extra $100 to replace it until I'm back to my waterline and start putting it toward investments again!