No, this is not some futures or commodities trading strategy. You don’t have to join a cult or an MLM. And you can do this for years.
The only qualification is that you have a mortgage or home equity loan.
You can achieve more than 100% returns on your money simply by paying extra money on your mortgage each month or as often as you like.
Here’s how it works: If you have a 30 year mortgage at 7%, for each $100 of your loan amount you will end up paying as much as $209 in interest. So within the 30 years of paying off your mortgage, you will repay that $100 that you borrowed PLUS you will pay up to an additional $209 in interest.
So if you “invest” an extra $100 along with your first mortgage payment, you will end up saving $209.42. That’s a return on your “investment” of 109%! And it’s guaranteed.
Plus you have just lowered the amount you are in debt and reduced the time it will take for you to pay off your mortgage. How many cold-calling investment brokers can offer you a deal like that?
So you could look at it as investing the $100 in your mortgage means that there is $309.42 you won’t have to pay out in the future. You could even argue that this is a return of 209%.
But what if you are several years into your mortgage. Well, even if you are 10 years into your mortgage (and the average mortgage only lasts about 7 years these days), you can still save $139.42 in interest by paying an extra $100. Or if you are 20 years into your mortgage you will still save $69.42 by paying an extra $100.
So what have you got to lose but your mortgage debt?
So why don’t more people do this?
Probably because the conventional “wisdom” says that if you can earn a better rate with an investment than what you are paying on your mortgage you should invest instead. If you are paying 7% on your mortgage and you can earn 11% in the stock market, it seems a no-brainer that you should invest in the stock market.
There are two problems with this philosophy: first, the 11% stock market figure that is widely quoted is an average over the past 30 years. Returns in the stock market have averaged on a yearly basis both higher and lower than the 11% rate. How do you know when you are investing in a year with negative returns? Unless you are in the financial industry you are probably taking as big a gamble as you would in Las Vegas playing the Roulette Wheel.
The other problem is that both inflation and taxes will eat away at your 11% return. Taxes can eat up to 2% of it and inflation can take another 3%, leaving you with only 6%, which is less than your mortgage. And that’s assuming you actually get the 11% return that year. Also remember that years in which high returns in stocks are enjoyed are also often accompanied by higher than normal inflation rates.
But some people will not be persuaded and will insist on investing in the stock market before paying off their mortgage and that is understandable. We all want to build some sort of retirement nest egg or have an emergency fund that is growing by more than the dismal rates offered by bank savings accounts or money market accounts.
But if paying down your mortgage makes sense at 7%, how much more sense does paying down your higher interest rate debts. If you have a credit card charging you as much as 24%, it makes way more sense to pay this off before investing any money in the stock market.
Some people would argue that it is good to invest always even if you have debt. But that is contrary to the overall goal of increasing your assets and wealth. For example, let’s say you owe $1058 on a 24% credit card and you have an extra $100 each month. You decide to make your minimum payments while investing the rest into the stock market.
If your stock market investment gives you a 12% rate of return you will have about $996 at the end of the year ($100 – min pmt x 12 months + “interest”). But you will still owe $1079 (more than you started with) on your credit card.
Viewed another way; you paid a total of $1200. Adding together the negative credit card balance and the positive investment value gives you have a net value of $-83.
Instead, if you use the full $100 to pay off your debt, you will be debt free at the end of the year. You won’t have an investment but overall you will not still be negative. The next year, you could invest the full $100 into the stock market. But if you still had your debt, you could only invest $78.50 while still making your minimum credit card payment ($100 – min pmt: $21.50 = $78.50).
Now if you take this scenario and play it out over 5, 10, 15 even 20 years you can see how paying your debts off now can save you $1000s in interest and help you pay off your debts sooner. Once your debts are paid off you can use ALL of the extra money to invest.
Numerically it is much better to pay off your debts first. But since your stockbroker makes his money off your investing what do you think his advice will be?
David Berky is president of Simple Joe, Inc. makers of the popular Debt Eraser PC software which helps to create a rapid debt reduction plan to get out of debt much sooner and save $1000s in interest. Visit http://www.simplejoe.com to learn more.