It’s the age-old debate. Which is better: to pay off your mortgage early or to make the payments for 30 years and invest your extra cash in the stock market?
The answer, honestly, will be different for everyone. It depends on a number of different factors and on your personal preferences as well. Some personal finance professionals and hobbyists will tell you to pay off the mortgage; others will tell you unequivocally to invest.
So, what are the pros and cons of one choice verses the other? And how can you decide which option is best for your individual situation?
The answers to those questions are riddled with “what ifs”, but we’ve got some information that may help you decide which route is best for you, both in terms of your personality and in terms of your financial situation.
Check out the considerations below and you should find some helpful tips for making a decision about whether you should pay off your mortgage or grow your investments instead.
Table of Contents
- The Benefits of Paying off Your Mortgage Early
- The Benefits of Investing in The Stock Market
- Which Choice is Best for You?
The Benefits of Paying off Your Mortgage Early
There are a few benefits to choosing the early mortgage payoff option over investing your extra cash. As you look them over, try to imagine yourself mortgage free and think about how that picture would impact your life for the better.
You’ll Save Thousands of Dollars
Yes, you will save thousands of dollars if you pay off your mortgage early. More like tens or hundreds of thousands of dollars, actually.
Let’s do some case scenarios so I can give you an idea of the astronomical monetary savings that comes with pre-paying your mortgage.
Case Scenario #1
In this scenario, you take out a $200,000 mortgage for thirty years with a 4.00 interest rate. If you don’t make any additional principal payments, you’ll have a $954.83 principal and interest payment and pay a total of $343,739 on your $200k loan over the thirty-year period.
That’s a total of $143,739 in interest payments that goes to the bank.
However, if you take out a thirty-year loan at the same interest rate and make payments of $1479.38 each month, you’ll pay a total of $266,287 for your mortgage loan.
So, you’ll pay the bank $66,287 in interest as opposed to $143,739 in interest.
That’s a savings of $77,452. If you took it one step further and took out a 15-year loan from the beginning, you could reduce your interest rate down a half percent or even more. With a 3.5 percent, you’d pay $257,357 over the life of the loan, reducing your interest payments by another $8930.
Would an extra $77k – $86k make a difference in how you lived your life? I’m betting it could. 🙂
Let’s look at another case scenario.
Case Scenario #2
In this case scenario, your mortgage balance when you purchase your home is $309,200 – the average mortgage loan amount for homebuyers as of January 2017, according to this Motley Fool article.
So, let’s use that mortgage amount for scenario two. If you took out a 30-year loan at a four percent interest rate with a loan balance of $309,200, you’d have a principal and interest payment of $1476.17.
Over the life of the loan, provided you didn’t make any additional principal payments, you’d pay $531, 420 for holding that mortgage.
However, if you paid extra on the thirty-year loan totaling $2287.12 a month for principal and interest, your total paid after fifteen years would drop down to $411,680 – a savings of $119,740.
If you took a 15-year loan from the beginning and had a 3.5 percent interest rate, you’d save an additional $13,805 in interest for a total savings of $133,545.
So, there’s no question that paying off your mortgage early will save you big time money. But the benefits of paying off your mortgage early go beyond monetary savings.
You’ll Reduce Your Cost of Living
If you choose to use your extra cash to pay off your mortgage early, your cost of living could be substantially reduced.
You’d still have to pay taxes and insurance on your home, but your principal and interest mortgage payment – and any private mortgage insurance you were paying – would disappear.
Just think about how life would change for you if you suddenly had an extra $1,000 to $2,500 a month with which to spend, save or invest as you pleased.
That kind of extra cash on a regular basis could open up a whole new world for you. You could take a lower paying job that you liked more. You could spend more money on travel or other hobbies.
Or you could make a substantial impact on the betterment of the world by giving more money to causes that are important to you.
A cost of living increase of that magnitude could definitely set things in place that would make life better.
You’ll Be Earning a Guaranteed Rate of Return
Another great thing about using your extra cash to pay off your mortgage early is that you’ll earn a guaranteed rate of return.
No worrying about stock market crashes or companies going under. If you’ve got a mortgage loan with a fixed 3.5 percent interest rate and you pay it off early, you’re earning a guaranteed 3.5 percent return on your “investment.”
If you’ve got a fixed four percent interest rate on your mortgage, you’ll earn a fixed four percent rate of return on your investment by paying down that mortgage early.
If you’ve got a variable rate on your mortgage you could be “earning” even more by paying your mortgage off early as you work to avoid the cost increases that come with a higher interest rate.
If you’re a person who has a low risk tolerance for investing, you can’t beat the guaranteed return on your money that comes with paying off your mortgage early.
You’ll Have Peace of Mind
And then there’s the peace of mind factor. Nearly every person I’ve ever talked to who has chosen to become debt free by paying off their mortgage tells me that mortgage freedom brings with it an amazing peace of mind.
They tell me about how the grass under their feet feels different when they walk through their yard or about how much better they sleep at night.
What would that feeling be worth paying for in your eyes? Would it change your life from an emotional standpoint, knowing that you’re not weighed down by hefty mortgage payments or by owing hundreds of thousands of dollars to the local bank?
Only you can answer that question. Some people don’t find it stressful to owe money, while others do.
These are just some of the benefits of choosing mortgage freedom over investing and to some they aren’t valuable benefits in the least.
Some people would rather take advantage of the tremendous benefits to investing their extra cash in the stock market or in some other form of investment, such as business ownership.
The Benefits of Investing in The Stock Market
Proponents of early retirement and millionaire status will often tell you without a doubt that investing your extra cash is the way to go.
And they could be right. After all, investing your extra cash as opposed to using it to pay off your mortgage early has its own set of attractive benefits. Let’s talk about those benefits now.
You Can Potentially Earn a Higher Rate of Return
Although stock market returns are never guaranteed, history has shown us that you’ll likely earn a better rate of return over the long term if you choose to invest your money in the market instead of using it to pay off your mortgage early.
While the market definitely has its ups and downs, the long-term average return of the market shows between seven percent and eleven percent, depending on who you ask.
However, even at a “dismal” seven percent average return, your return on investment could double compared to the return of three or four percent return you’ll get by paying off your mortgage early.
If you end up getting a return closer to eleven percent, you could triple or quadruple the ROI you’d be getting by paying off your mortgage early.
And a higher return means more wealth for you. Wealth that you could use to retire early, travel the world, and yes – pay off your mortgage, with reserves in the bank to boot.
But there are other benefits to investing your extra money instead of paying off your mortgage early as well.
You’ll Have More Liquid Cash Available
One of the things investors like about having money in the market as opposed to using it to pay off a home early (along with the much higher returns) is the investment liquidity.
Think of it this way: The equity in your home isn’t truly liquid. In order to access it you need to do one of two things: you need to sell your house, or you need to apply to get a home equity loan or line of credit.
Selling your house could take days or it could take months, depending on the state of the housing market at the time you choose to sell.
And if we’re in the middle of a housing value dip you could walk away with much less than you’d planned on if you sell during a housing market downturn.
Getting a home equity loan or line of credit also takes time. You need to apply, wait for approval, and wait for the documents to be created.
These wait times can vary depending on your bank or credit union’s processing system and current in-process loan load. If they’re super busy processing loans you could have to wait.
After you sign the documents on your home equity loan or credit line you’ll have to wait for the three day right-of-rescission period to come to pass.
Only after these steps are completed will you have money in your hands.
If you choose to invest your money instead of using it to pay off your mortgage early, your money is much more liquid.
A quick call to your investment broker or an online transfer and you’ll have cash in your checking or savings account within a day or two.
That kind of liquidity could be a major benefit if you come upon a sudden need for cash such as a job layoff.
Also, if you do suffer a job layoff you could run the risk of not being approved to take out a home equity loan or line of credit because of a lower (or non-existent) income.
Liquidity is definitely something to think about as you make your decision regarding investing vs. mortgage payoff.
You’ll Still Have Your Mortgage Interest Tax Deduction
Another benefit to investing as opposed to paying off your mortgage early is that you’ll be able to keep deducting the interest you pay on your mortgage, provided you qualify for that tax deduction and the IRS doesn’t change the current rules.
It’s nice being able to wipe $10k or more off of your taxable income just for owning a home with a mortgage, isn’t it?
If you itemize your tax deductions by using the mortgage interest deduction and other deductions, you may want to keep that mortgage deduction option available.
So, we’ve talked about some very real and attractive benefits to paying off your mortgage early, and some very real and attractive benefits to investing instead.
How do you decide which choice is best for you? Here are some things to think about.
Which Choice is Best for You?
As I mentioned early, the answer to the question “Should I pay off my mortgage early or invest my money” will be different for everyone.
There are both emotional and logical questions that need to be answered before you can make the decision that’s best for you and for your family if you have a spouse and kids that share your life.
What kind of questions do you need to answer for yourself? Well, you can start with these.
What is Your Risk Tolerance?
When I talk about risk tolerance, I’m talking about your emotional ability to handle risk. This is an important question, my friends.
Some people (and I’m one of them) do not have the emotional strength to handle large amounts of risk.
The stock market does indeed go up. In fact, in the last ten years the market has jumped well over 200%, and a lot of people have been making a LOT of money.
However, what goes up must come down. A major stock market crash could grace our shores tomorrow. Or next week. Or next month. Or not for another ten or more years.
The truth about the stock market is that although there are signs before major corrections come, you likely won’t be able to predict with much accuracy when your investment account will take a major hit.
If this truth sends your stomach into waves and makes you feel light-headed to the point of panic, you might be better off taking your extra cash and using it to pay that mortgage off early.
However, if you’re comfortable with the fact that the market goes up and down, and with the thought that your money could take a big time hit if there were a major market correction you may want to invest.
If you’re one of those people who could handle a major market correction and an accompanying loss of tens of thousands of dollars with a “que sera sera” attitude, then investing might be the better way to go for you.
There’s no right or wrong answer here, but it is vitally important that you have an in-depth understanding of your risk tolerance and how you really feel about the possibility of losing your hard-earned cash in a market crash.
That being said, history has proven that what goes down does come back up.
If you’re invested in a market with a proven long-term record like the S&P 500, even major losses have a high chance of coming back, although that bounce back may take several years.
My best advice as far as risk tolerance is concerned is to have a real heart-to-heart with yourself – and your spouse – and work to determine how much risk you’re willing to take in hopes of gaining higher returns.
If either of you are too uncomfortable about the risks that come with investing in the stock market, you may want to look more closely at choosing to pay your mortgage off early instead.
How Much Do You Know About Investing?
Another very important question in deciding whether you should pay off your mortgage or invest pertains to how much you know about investing.
A bad investment choice could mean a permanent loss of your money, as in forever and ever.
For instance, if you invest in Uncle Joey’s new tennis shoe company and Uncle Joey runs off with the cash or his not-so-brilliant idea to create a tennis shoe that will rival Nike doesn’t work, your money will likely disappear forever.
Conversely, if you have a relationship with a knowledgeable investment professional who has a long term proven history of giving successful investment advice, you could really rake in some serious cash over time.
I’m not talking about getting in on the bottom floor of the next “big thing” here. Although IPOs and penny stocks can produce big returns, it’s super rare for that to happen.
Most successful investors such as Warren Buffett and John C. Bogle will tell you that slow and steady wins the race.
They’ll share advice such as “invest in blue chip stock choices and stay there over the long term.” They’ll tell you to stick with tried-and-true companies and to beware of up-and-coming newbies.
So, although you don’t need a professional advisor to guide you if you choose to invest instead of pay off your mortgage, you should at least spend several hours educating yourself on investing if you haven’t done so already.
You can do that by reading popular investing blogs as well as books by coveted investors.
Books such as John C. Bogle’s The Little Book of Common Sense Investing or The Intelligent Investor by Benjamin Graham would be among my top recommendations as far as books on investing are concerned.
Know what you’re doing before you invest in the stock market, or hire someone who does and make sure to get quality references before you hand over your cash.
What Are Your Financial Goals?
Your financial goals are another consideration to make before deciding whether to invest your cash or pay your mortgage off early.
What is it that you truly want from your money? What are your short and long term financial goals?
- Are you saving enough in retirement funds?
- Do you have kids’ college tuition that you need to save for?
- Do you have any high interest consumer debt that needs to be paid off?
- Are you properly insured?
These are all questions you can ask yourself that can help you to decide what to do with extra monthly cash flow as well.
Let’s go into specifics about these questions and how you can better determine if these financial goals – or others you may have – should be addressed before putting extra money on your mortgage or investing.
How Much Do You Have Saved for Retirement?
Retirement savings is a big one. It’s important to be taking advantage of any employer match (i.e. free money) and be saving for a plush retirement that can cover any costs you may have in the future.
Check out this article to learn more about how much you should have saved in your 401k based on your current age.
If you don’t have enough saved for retirement, you may want to put some extra cash toward that financial goal before you consider paying off your mortgage early or investing in non-retirement accounts.
What is Your Current Debt Situation?
It’s also important to look at your overall debt picture. Are you currently carrying lots of consumer debt such as credit card balances, car loans and consumer loan balances?
If so, you may want to consider getting those balances paid off first, especially if you’re paying higher interest rates on your consumer debt.
For more on how to pay off consumer debt quickly, check out this story on how Deacon and his wife paid off $52,000 in consumer debt in just 18 months.
Consumer debt can be a serious roadblock to building wealth and to retiring early and retirement in general, and it’s a good idea to get it paid off as soon as you can.
Do You Have Kids that You Plan on Helping with College?
It’s not a requirement that parents help pay for their kids’ college costs. If you’re planning on helping your kids by paying some or all of their college costs, that’s great.
However, it’s important that you put yourself in a solid financial position first. Doing so can include paying off any consumer debt, and making sure you’re contributing enough towards retirement.
It can also mean making sure you’ve got at least six months’ worth of expenses in your emergency fund and a debt-to-income ratio of 25 percent or less.
By working to ensure sure your own financial situation is rock solid before you start contributing toward your kids’ college educations, you can be sure they won’t end up supporting you in the future as you struggle with significant debt and inadequate savings.
If you decide that helping your kids with college costs is of high importance to you, make sure you have a plan in place to do that before you put extra money toward your mortgage payoff or toward investing in non-retirement investment accounts.
Do You Have Adequate Insurance?
Insurance is an important part of a solid financial plan. Before you put extra money toward mortgage payoff or non-retirement investing, make sure you are insured appropriately for your individual familial situation.
This means making sure you have enough homeowners’ insurance, adequate vehicle coverage, appropriate medical insurance coverage and adequate life insurance coverage.
Planning for the “what ifs” in life by obtaining adequate insurance coverage should be of a higher priority than paying off your mortgage early.
When you’ve got enough money saved and invested to cover any type of emergency and provide for your family for many years to come, then you can consider dropping the life insurance policies.
What Are Your Other Financial Goals?
Other financial goals are important to consider as well. Is it your goal to achieve millionaire status? To retire early? To switch to a career that pays a lot less than your current job?
The big picture of your financial goals must be considered before you make serious efforts to reduce debt by paying off your mortgage or grow your wealth via investing.
By having a clear picture of what all of your short and long term financial goals are, you can better develop a strategy for managing your money that will help you reach ALL of your goals.
And that strategy will help you reach those goals in the order that’s most important to you and your family.
After all, you work hard. Make sure you’re working in a way that will help you reach the dreams that are most important to you and those you love.
To sum it all up, the answer to whether you should pay off your mortgage or invest your money is that there is no definitive answer. Your choice depends on a number of different things. It depends first of all on your current money situation and your current short and long term financial goals.
After you’ve determined what those goals are and where you currently stand financially, you can ask yourself what you need to do to get on solid financial ground.
Once you’ve reached that place – or if you’re already on solid financial ground – you can begin working to find the answers that relate directly to paying off your mortgage or investing.
Questions such as what is your risk tolerance and which form of financial growth will most benefit you and your loved ones?
For instance, if you’re interested in retiring early, it will serve you well to have a mortgage free home. It will also serve you well to have a seven figure non-retirement investment account.
Recommended Reading: You Can Retire Early by Deacon Hayes
You might end up deciding that the best choice for you is a hybrid plan; one where you put some of your extra money toward paying down your mortgage early and some of your money toward investing.
This is actually what a lot of people end up doing. No one says you have to choose one or the other.
You do have the option of creating a hybrid plan based on your answers to the questions above. For instance, if you have $1,000 extra a month to play with, you could put $500 toward additional principal payments on your mortgage and $500 in an investment account.
Or you could put $300 toward your mortgage and $700 into investments. The great thing about it being your money is that you get to choose how to best manage it given your goals and your financial situation.
If you start with Plan A and find that’s not working, you have the option to switch to a Plan B that will better help you achieve your goals.
The point is to make sure you are working toward achieving those goals. Avoid wasting your extra cash on things that don’t truly matter to you (like that daily coffee drive thru run or that cable TV subscription) and start putting it toward achieving your financial goals.
Once you’ve put yourself in a financial situation where you don’t have a mortgage payment tying you down and you’ve got a seven-figure investment account you have the freedom to do what you truly want to do with your life.
Now I have a question for you (actually it’s two questions in one). If you had to choose between the two what would you do: put your extra cash toward paying off your mortgage early or invest it in order to grow your wealth, and what is your reason for your choice?