Should You Pay Off Your Mortgage Or Invest?

Should You Pay Off Your Mortgage Or Invest?

When it comes to optimizing your money, one hotly debated topic is whether you should use your available income to pay off your mortgage faster or invest the money for the greatest return. The future is unknown, but there are emotional and logical arguments to be made for investing or paying off the mortgage first.

Planning for financial independence means you consider even more factors to find the right answers for yourself. To invest or pay off the mortgage, is the question. Let's take a look at the arguments so you can make an educated decision about which is better for you. After all, personal finance is personal and this is a decision you’ll have to make for yourself.

The Arguments for Paying Off the Mortgage

There’s something special about being completely debt-free including the mortgage.

When you’re debt-free, not a penny of your income should go toward making interest payments. You no longer worry about setting aside a portion of your monthly income to pay for your housing. While you do still pay for things like repairs, maintenance, insurance and taxes, these costs won’t be nearly as big as the principal and interest on a mortgage payment, in most cases.

When you’re no longer making principal and interest payments for a mortgage each month, chances are your monthly expenses will decrease by quite a bit. This also reduces the amount of money you’d use in calculations to see how much money you need to set aside for FI like the 4% rule.

If you have carefully planned to pay off your mortgage before you reach FI, the reduction in expenses due to no longer having a mortgage payment could play a big role in your plans.

While others would rather invest money to potentially earn a higher return, those that decide to pay their mortgage off have one major fact on their side. Paying down a mortgage gives you a guaranteed return on your money. If you make extra principal payments on your mortgage, you don’t pay interest on that money you no longer owe.

The guaranteed return on the money you put into your mortgage will be the interest rate of your mortgage. Of course, this assumes your home value stays constant or is increasing. If the value of your home is decreasing, this may not hold true.

Emotionally, paying down your mortgage may make more sense, too. While investing to reach FI definitely speeds up the process rather than just putting money in a savings account, sometimes it’s harder to get excited about building up an investment account than it is to get excited about paying down a mortgage.

When my wife and I were paying down over $80,000 of student loan debt, we did everything we could to put a few extra dollars toward paying off that debt. I imagine there is a similar feeling when someone is trying to pay off their mortgage quickly. That same intensity may be more difficult to achieve when it comes to investing, resulting in putting more money toward paying down the mortgage than you would invest.

Related: How To Apply For A Mortgage While Pursuing FI

The Arguments for Investing

While paying off the mortgage may be the emotional option, investing is often seen as the logical option to optimize your money. Mortgage rates have recently been at all-time lows. Mortgage rates of under 5% make it easy to see how investing rather than paying down the mortgage could result in a higher return for your money. If your average rate of return on your investments is at least 8%, you have quite a bit of wiggle room above the 5% or the lower rate you’re probably paying on your mortgage.

Related: M1 Finance Review: Completely Free Automated Investing

Another reason why investing is the logical answer to the debate is the fact that the principal and interest portion of a fixed-rate mortgage will remain the same each year as time goes on. So, you can use future dollars that are worth less than today’s dollars, due to inflation, to pay off your mortgage. You don’t have to lower your returns by the rate of inflation because your mortgage payment won’t be increasing with inflation as all of your other expenses will.

Here’s a quick chart that shows the difference in the time it would take to pay off a mortgage between applying the money toward a 5% interest rate mortgage versus investing that money at an 8% annual return. This also assumes a brand new 30-year fixed-rate mortgage with a $200,000 starting balance.

Extra Principal PaymentsYears To Pay Off Mortgage With PrepaymentsYears For Investments To Reach Mortgage Balance Remaining With No Prepayments
Extra $50015 years 2 months13 years 11 months
Extra $1,00010 years 4 months9 years 6 months
Extra $1,5007 years 11 months7 years 5 months

Keep in mind, you may have to pay taxes on your investment earnings and dividends you may receive. On the other hand, you won’t be able to deduct your mortgage interest unless you’re one of the few people that will still itemize your deductions after the recent tax law change.

Ultimately, You Decide

What matters is you decide what is best for you and your situation. Keep open to adjusting as future needs and wants to become evident. Compare the numbers; the interest rates, the time intended in the home, and your risk tolerance. And remember, you can do a little of both if you’d like or change your mind and switch methods later on. The decision is in your hands.

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Should You Pay Off Your Mortgage Or Invest?

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30 thoughts on “Should You Pay Off Your Mortgage Or Invest?”

  1. Good information Lance!

    The unfortunate part is, I still get all torn up over this one… I understand the benefit of having it paid off and reaching that magical FI number, but goodness I am still trying to acquire more and more shares right now.

    I go back and forth on this one a lot, and ultimately I end up doing nothing towards paying down the mortgage but everything towards investing. One day I may finally make a decision to pay it down faster.

  2. I have decided to do a hybrid approach. I add a small amount of principle to my mortgage each month, and then I add some to my taxable account. This decision tends to be psychological. Thanks for the article.

  3. Lance I’ve been trying to figure out this for a long time. Is there a calculator that you use to find out if there’s a break even? If not then how do you do the math?

  4. Debt enslavement is a trap. Don’t be fooled by the argument that mortgage debt is ok. Real Estate ownership is a powerful tool for freedom and supports the lowest level of Maslow’s hierachy of needs. Get that out of the way as soon as you possibly can, so you can focus your life on the more important and higher level goals of human existence. Or you will NEVER be out of the clutches of the banksters. Slam that mortgage down with every dollar you can and get your freedom back. Remember FI = Financial Independence. You can’t pretend you are at FI if you have no independence because you have a mortgage. 100% free or nothing.

    • And live happily for the next 60+ years in your paid-off house, Bradley.

      I set up my mortgage to pay every other Friday, the dates I get paid. It shaves a few years off my 15 year mortgage, same as paying 13 months instead of 12. It costs me nothing to do.

  5. I’m not an expert in this area, but I’ve been told home equity on the table when funding college whereas retirement funds are not. If someone is looking to put kids through college in the future and is trying to decide between maxing the 401(k) and paying off the mortgage, it would be worth researching this a bit more before making a decision.

  6. You can never be free of housing costs,Bradley. If you fail to pay your property tax, you will still lose your house. Most wealth is built through leverage. It can work for average people too on a smaller scale.

  7. My husband and I are a couple of years into a 15-year fixed rate mortgage at 2.75%. We’ve got enough in savings/investments to pay it off. Just checked this morning and lists two-year CDs paying 2.75% and five-year CDs paying 3.25%. Paying the mortgage off early would actually delay our FI, since a completely safe, FDIC insured CD would earn more interest than our mortgage costs us. And that’s not even considering the probable higher returns (albeit with some risk involved) from investing in the market, index funds, etc.

    • Keep in mind with this reasoning you need to account for the after-tax rate of return you get. You will pay your marginal income tax rate of on the CD interest which is taxed at ordinary income rates.

      You will only get a like-for-like return between a CD and Paying off you mortgage if you are still able to itemize your mortgage interest which would mean you lose that tax shelter if you pay off your mortgage. In that case the interest saved on your mortgage would be offset by the additional federal tax you pay from losing your deduction. As it states in the article, most individuals will no longer itemize (ie just use the standard deduction) which means you get to realize the full mortgage interest rate as your rate of return and only the after-tax return on a CD.

      CD interest * (1-marginal tax rate) = after-tax return on CD

      For example:
      I have an extra $50,000 to either put in a CD or pay off my mortgage (assume I am in the 22% marginal tax bracket)

      1 Year CD Return
      $50,000 * 2.75% APR = $1,375 interest * (1- 22%) = $1,072.5 After tax return (excluding any state or local taxes)
      Realized return = $1,072.5/$50,000 = 2.15%
      for the 5 yr CD after tax rate of return = 3.25% * (1- 22%) = 2.535%

      1 Year Return for Mortgage Reduction

      If itemizing:
      Pay off $50,000 of principal will reduce interest for the year by the same $1,375 but I lose a deduction of $1,375 on my tax return
      so I end of paying an extra $1,375 * 22% = $302.5 extra federal tax bill for the year and my after tax return is the same 2.15% as the 1 yr CD

      However, if I just take the standard deduction, I will not pay additional federal taxes from paying off my mortgage and my realized return is equal to my 2.75% Mortgage rate

  8. I have considered making additional principal payments and investing less when the markets are over valued and investing more and paying for smaller additional principal payments when the markets are undervalued. You can use the Shiller PE Ratio to determine how overvalued/undervalued the markets are.

  9. Contradiction to: “The certain return on the money you put into your mortgage will be the interest rate of your mortgage.” If the loan is amortized, like most mortgages and auto loans, additional payments towards principal rarely equal the interest rate of the loan. The amount of interest paid is dependent on the amount of principal, therefore greatest at the beginning of the loan and decreases linearly as you pay off the debt.

    Does anyone know of an online calculator to show what percentage you are truly receiving by paying off a debt prematurely?

    • I understand what you are saying, Sofie, but it is not accurate. If you pay an additional $1000 toward principal in a month, then for the rest of the loan term, the interest charged monthly considers that you no longer owe that $1000. Let’s say you are paying on a 3.5% loan, to calculate the return in a given month of the additional payment, it is $1000 times .035 mortgage rate divided by 12 months per year equals $2.91 less in interest every single month. This is in addition to the reduced interest you owe due to the amortization factor you described from paying your normal principle for that month. To compound on that, the $2.91 gets applied to the principle reduction every subsequent month, resulting in even lower interest paid for the rest of the loan term.

  10. Great write up covering a few key aspects. For those are interested, I found this other write up extremely helpful as well.

  11. My wife and I chose to pay off our mortgage, but not until we felt like we had a good start on our retirement savings and other investments. Initially we decided it made the most sense to invest and just carry the mortgage for 30 years. But I’m self employed and my income fluctuates, so eventually we decided not having a mortgage payment would help us feel more comfortable with an unpredictable income. I don’t regret paying if off at all, although I think on paper it would have made more sense to invest.

  12. One of the things that no one seems to talk about is how having a mortgage or paying rent affects your Sequence of Return Risk once you retire. I ran the Personal Capital Retirement Planner about a dozen times with various scenarios and here is a summary over a projected 40 year retirement:

    Senario Home Cost Monthly Cost Fail Rate
    Own House $350,000 $300 3%
    Rent $0 $2100 30%

    So I have a 30% chance of running out of money if I have to pay $2100/mo even if I keep an additional $350,000 invested at 70/30 stocks/bonds. Since I’m FIRE, from a risk mitigation point of view it makes sense for me to take the $350k out of my portfolio and buy a house outright. I’m sure everyone’s situation is different, but I just wanted to offer this up as food for thought. -Lance

  13. Great article guys. Actually, a few days before this came out, I wrote a piece on the exact same scenario on my European FI blog.

    I think that the answer depends on your stage in life. If you are young, still working, and your mortgage interest is low, I would rather invest than pay off my mortgage. However, if I’m getting closer to FI, having properties paid off means I need less cash flow to live on. So even though my mortgage rate is super low, I might start paying off my mortgage faster when I’m reaching FI.

  14. You also need to consider that the interest on your mortgage is basically a simple interest “cost”. Meaning that you don’t accrue more interest that needs to be paid off by simply making the regular mortgage payment. So the 8% investment ROI vs. 4% mortgage interest cost is actually too simple. If your time horizon is 20 years, it’s not only the delta on 8% vs. 4%, but also the fact that dollars invested early in the 20-year time-frame have a long-time to compound, tilting it even more in favor of the investments (and this is, of course, dependent on sequence of returns …)

    On the flip side, it’s hard to put a price tag on the emotional freedom of having your home paid off, and if you’ll still achieve your FI goals in a reasonable time frame, maybe you decide to do that. It’s not always about the bottom-line dollars.

  15. We paid off our house ~3 years ago. The psychological benefits of that fact are hard to describe. The $250,000 lbs gorilla is off our back! I do not regret “loosing” the opportunity cost of investing the mortgage money verses paying off the house early, even though mathematically it may be illogical. I understand the math perfectly well. I can always borrow against the house and the invest the money if I want to, but I don’t think I will, not ever. The feeling of relief from being out from under the mortgage is very real. If either one of us gets laid off from work, it’s an inconvenience, not a crisis. We can live indefinitely off of either one of our incomes. The likelihood of ever being forced to sell or move is almost nil. We won’t ever need to sell investments at an inopportune time or cash out of retirement accounts to cover a mortgage payment. I’ll decide when it’s the right time to sell a stock. I’m not as concerned about what happens at work or whats going with the market. Having a paid off mortgage is like a mini sneak preview of being FI and it doesn’t suck.

  16. I think assuming equities will return “at least 8%” when doing calculations like this is very risky, especially when market valuations appear to be so high (according to most measures). Also, regarding a comment made above, mortgage interest compounds in the same way as investments do. So you can dramatically reduce the total amount you need to pay over the full term of a mortgage by paying off a chunk of it early. Many mortgage holders today don’t even know what it’s like to live in a high interest environment, but we shouldn’t assume it can’t happen again.

  17. How does this conversation change when the mortgage interest rates increase and the market cools? Bogle says to expect a 4% return over the next decade (over inflation). If your mortgage goes up to 5% then does it make sense to invest vs pay off your mortgage? Also, it’s true about being motivated to pay off debt vs. invest. It’s so much easier to get excited about paying down debt than investing every last dollar!

  18. “The certain return on the money you put into your mortgage will be the interest rate of your mortgage. Of course, this assumes your home value stays constant or is increasing. If the value of your home is decreasing, this may not hold true.”

    I agree that the return on your money will be the interest rate of your mortgage. I disagree with the statement that this assumes your home value is constant or increasing, and this may not hold true if your home value decreases. Once you’ve taken out a mortgage, you owe that money whether the home value goes up or down. Correct me if I am wrong on this.

    FWIW, I struggle with the invest vs pay down the mortgage decision all the time. Right now, we’ve decided to pay down our mortgage because we think the market is over valued. That said, we still are investing in our 401K.

  19. This is such an exciting topic of debate! I love to see all the comments and feedback and thanks to everyone for sharing!

    The way I see my payment today is it’s $420 principle and $410 interest. The real cost to live in my home each month is only the $410 interest as the price of the home is “locked in”. I’ve already agreed to pay the bank back the loan of a few hundred thousand and the home is worth much more than the loan so there is very little real risk of further loss beyond the interest payment. Depositing hundreds more each month into principle only lowers the interest payment a few dollars. Since I know what the cost of the principle is going forward, I only see the monthly cost as $410 AND DROPPING each month. How many times in life do you get to enjoy something daily and have it cost less each day? When we first moved in we were young and really strapped for cash for such a LARGE payment. Now I chuckle at the payment and think it was one of the best decisions we’ve made. Our home has a lifetime of memories and more to come…for only $410/mo…and falling.

    Having said all this…yes we did throw money at the principle for many years to get it down. Now that I see the math better, I see that was probably a mistake, but not the worst mistake to make. True first world problem for a FI follower….do I invest and make money or own my home sooner? If I had to do it over again, I would have invested the extra payments. I have, of course, the power of hind site here knowing that my life stayed in one place, the market went up (even through 2007-2009), and my home is still worth something above the loan. The power of inflation and compounding is often overlooked.

    FI on everyone!

  20. Could everyone ALSO take into consideration the reduction in financial risk when a home is completely debt free?!?!?!

  21. Of every extra dollar, we’re putting 50% into mortgage and 50% into retirement investments. I got too burnt out trying to decide so I’m doing both.

  22. I’m 30 and own a rental property with a 30 year mortgage at 4.625%, which I purchased 4 years ago. The monthly principal/interest is $1k/month. My profit is $600-700/month. I’ve done some math and should be able to pay off the mortgage in 3 years if I throw all my extra cash at the principal. I have $150k remaining on the principal, but have some savings to get it under $130k by sometime in Jan 2020.

    Once this is paid off, my monthly profit will increase by $1k, so I would be making $1,600-1,700 per month. The stress relief I feel will be amazing to not owe any money to a bank.

    Also, I will be close to “half-FI.” My monthly expenses are about $2,000 per month, but this might increase to $3,000 or more in the future if I have a family.

    If I invested all the money instead of paying off the mortgage, I would still be stressed about the mortgage debt. Also, there is the opportunity cost of increasing my monthly profit by $1k. Mathematically, paying off the mortgage early is not the wisest decision. But for me, the benefits of the extra monthly income and stress relief are worth it.

    My retirement plan is to make money through real estate, so I’m not very interested in 401k or Roth IRA for now. Once I’m FI, I do plan on maxing out retirement accounts.

    My fear is that the stock market will crash sometime in the next 3 years. So, I feel safer knowing I have a “guaranteed” rate of return by paying off the mortgage.

  23. Such a rich and fascinating debate/conversation!

    I want to highlight that context really matters and it’s not just a matter of comparing a) putting $x toward a mortgage versus b) putting $x in investments. That is a huge part of it, for sure. But our entire financial lives are the bigger picture and absolutely shape and impact the decision, and not just psychologically but also financially. Things like age and distance from FI/retirement, age of kids (ie relevance of FAFSA), cash flow, types of sources of income in retirement, etc. also matter. Here are some of the factors we are also thinking about as we debate paying down mortgage vs other options that I don’t read or hear much about:

    – Our kids are 14 and 17. The FAFSA (free applications for federal student aid) determines how much need-based financial aid people qualify for. Money invested in taxable accounts counts as money the parents could put toward the kids education and increases the expected family contribution (EFC); this means the more money I have in taxable accounts the less need-based financial aids my kids can qualify for. However, equity in your primary residence does not increase the EFC, so doesn’t negatively impact how much need-based financial aid my kids could get.

    – We are aiming to FI/RE in 5 years and we have 11 years left on our mortgage. If we don’t accelerate payments we will be making mortgage payments for the first 6 years of our FI/RE. The principal and interest on our mortgage is $1,391/month or $16,692/year. That means we need to have an additional $16,692 in income. We expect to be in the 12% income tax bracket and based on the particulars of our scenario that $16,692 will fall into that bracket, which means we have to have approx. another $2,000 on top of the $16,692. Of course I’m paying income tax on that same amount of money now while I’m working; but it’s much easier to swallow that while working. Carrying that mortgage into retirement leaves me feeling like I’m paying an additional 12% surcharge on top of my mortgage.

    – Who knows where the US health care system will be in 5 years. But currently, the Affordable Care Act system is set up to provide subsidies based on your income level as it relates to federal poverty level (FPL). Based on our particular scenario, the additional roughly $19,000 in income we’d need to pay our mortgage each year in FI/RE would bump our overall income up in such a way that we would lose at least $1,000/year in health insurance subsidies.

    One other thing I haven’t read much about in the FI/RE world is recasting your mortgage. I can pay more down on my mortgage early and I *don’t* have to refinance or wait until the end of the mortgage to benefit. Before I learned about recasting, I thought that if I paid, for example, one year’s worth extra on my mortgage it just meant that it would shorten the mortgage by one year, which I wouldn’t experience the benefit of until the very end of the mortgage. In our case, with 6 years of mortgage in my retirement, shortening that to 5 years didn’t feel very exciting or particularly useful financially. BUT, then I learned about recasting. I can pay that one year extra now and then recast–meaning the mortgage company will redivide my principal over the remaining term of the mortgage bringing down my payment every month (while keeping the same interest rate) So, I achieve all the interest savings of paying down ahead of schedule AND I bring down my monthly payment for every single month for the rest of the mortgage. While working, we can use those monthly savings to pay down the mortgage even further or invest, and when we’re no longer working we’ve dropped the amount of income we have to have to cover our mortgage. So we have decided that after maxing out all our tax-advantaged avenues we are going to pay down the mortgage and recast after we’ve reached a significant chunk. NOTE that recasting options vary so check with your mortgage company to see what’s available to you.

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