Key takeaways
- Using extra cash to pay off your mortgage loan early can save homeowners a hefty amount of interest over time.
- However, putting available funds into investments instead might yield a more significant return and make you more money.
- The answer to which is right for you will depend on your risk tolerance, your financial circumstances, your interest rate and more.
Many people view debt as the financial enemy and strive to pay it down as quickly as possible. While that can be wise for high-interest obligations like credit card balances, when it comes to mortgages, the math isn’t as clear-cut. Some experts say you’re better off putting any available funds you might have toward investing, while others believe it’s best to pay off your debts first before you focus on investments. As you weigh your options, here’s what to consider.
Should I pay off my mortgage or invest?
There’s no one right answer to this question, and a lot depends on your interest rate and current market conditions. While paying down your mortgage ahead of schedule may be of financial benefit, you may find that your returns on new investments will exceed any cost savings you could stand to gain by paying down your mortgage balance.
Unlike other types of loans, mortgages are considered “good” debt because they’re tied to an asset — your home — that typically appreciates over time. What’s more, mortgages qualify as “cheap money”: In contrast to personal loans and credit cards, home loans carry lower interest rates. Because of this, some financial advisors believe you should leverage your mortgage rather than eliminate it. Take out that 30-year loan, keep it for as long as possible and devote any extra cash flow to investments or other goals.
“Mortgages are the cheapest money anybody could ever borrow,” says Claire Mork, executive director of financial planning at Denver-based Edelman Financial Engines. “I think of it as a financial tool.”
Not everyone agrees with that approach, though. Chris Hogan, a Nashville-based consultant and author of “Everyday Millionaires,” advises clients and audiences to pay down their mortgages as quickly as possible and sees debt as a “threat.”
The average person has to fall back to, ‘What is my tolerance for risk?’
— Ken Johnson, Walker Family Chair of Real Estate, University of Mississippi
Both strategies are viable in theory, says Ken H. Johnson, the Walker family chair of real estate at the University of Mississippi. “The average person has to fall back to, ‘What is my tolerance for risk?’” says Johnson.
Risk tolerance is your ability to roll with ebbs and flows in the market, or more directly, your willingness to endure loss.
If you can reach your financial goals while continuing to invest, doing so might be the best decision. But if you need your assets to remain intact, real estate is traditionally a more stable place to keep equity.
Pay off mortgage or invest? Factors to consider
A 30-year mortgage comes with pros and cons. On the upside, the payments can be on the low side (especially if you managed to refinance to a very low rate in 2020 or 2021), so there’s not as much urgency to pay down the debt. On the downside, you’ll pay a lot in interest over the life of the loan.
When you’re debating whether it’s better to pay off your mortgage early or invest, ask yourself the following questions:
- Do I have sufficient emergency savings? Conventional wisdom advises that consumers save up between three and six months’ worth of living expenses to cover costs during an emergency or unexpected income interruption. Your answer to this question will depend on your risk tolerance, capacity to save and existing financial obligations.
- Am I putting away enough for retirement? As with emergency savings, expert stances vary on how much you should have saved up for retirement by different ages and stages of your career. You may look ahead to which withdrawal strategy you plan to use down the road to decide how much you should be saving now.
- How much other debt do I carry? Assessing your complete financial picture is key when determining your debt payoff priorities. Identifying which debts you should pay down first can help you to save on interest, maximize your investment potential and balance responsibilities.
- What are my prospects for increasing my income? Whether this involves getting a raise at work or picking up a side hustle, your prospects for increasing income are another consideration in deciding whether to focus on investments or paying down your mortgage first.
- What moves am I looking to make in the next year? In the next five years? Be sure to assess housing market conditions before making any decisions. Keep mortgage amortization front of mind, too: An amortization calculator can help you see how much of your monthly payment is going toward the loan’s principal versus interest. If you’re midway into your loan term and making significant headway, you may choose to stay put and build equity.
- How does my mortgage rate compare to expected portfolio returns? Monitor your investment portfolio, assessing both near- and long-term return rates. A good benchmark to use in this situation is the S&P 500, which has historical average returns of 10% annually. If your investment returns outpace the national average mortgage interest rate, consider keeping your current mortgage and accelerating your investments.
Pros and cons of paying off your mortgage quickly
Paying off your mortgage early can save you money, but how much you can save depends on your interest rate and how early you pay off the loan. You can use an amortization calculator to figure out how much you could save by paying off your particular mortgage loan early.
For example, let’s say you have a 30-year mortgage for $400,000, with a 6.5% interest rate. If you pay the loan off in 30 years as planned, you’ll pay a total of $510,178 in interest over the life of the loan. But if you pay off the same loan in 20 years, your total interest amount goes down significantly, to $315,750.
Pros
- Paying off your mortgage eliminates a large monthly expense, providing more cash flow.
- The sooner you pay off your mortgage, the less interest you’ll pay overall.
- Your credit score tends to go up as you pay down debt, so paying off your mortgage might boost it.
Cons
- Putting all your excess cash into your mortgage means tying it up in an illiquid asset. You won’t be able to access that equity unless you take out a second mortgage, do a cash-out refinance or sell the home.
- You’ll lose the ability to take the mortgage interest deduction on your taxes.
- Housing appreciates at a lower rate over time than the stock market.
As Hogan interviewed millionaires for his book, he discovered a common theme: Many paid off their mortgages early or as quickly as they could instead of holding onto the loans to term. If you decide to take this route, Hogan advises putting 15% of your income toward retirement savings and using any extra cash to trim mortgage debt. If you must have a mortgage, he suggests taking a 15-year loan to get rid of the debt faster and pay far less in interest.
Pros and cons of investing instead
How much do you stand to earn by investing? Here’s an example, using Bankrate’s return on investment calculator: If you make an initial investment of $10,000 and add another $10,000 each year for 10 years, you will have invested a total of $100,000. If you expect a 7% rate of return, you’ll earn a total of about $157,836 when those 10 years end. Weigh that against how much you stand to pay in interest over the course of your 30-year loan.
Pros
- The stock market has historically returned an average of about 10%. While that’s not a sure thing, if your mortgage rate is less than 10%, you could come out ahead by investing.
- Stocks, bonds, mutual funds and ETFs are highly liquid, meaning you can sell them easily if you need the cash for other purposes.
- If you put money into a retirement account, you might be able to take advantage of perks like employer matching and tax breaks.
Cons
- Stocks are volatile, and there are no guarantees. A bad year or two could put a big dent in your portfolio.
- For many people, their mortgage payment is their biggest monthly expense. If you invest instead of paying the loan off, you’ll still have to make that payment.
It’s nice to be debt-free sooner, of course, but you could be sacrificing an opportunity to build retirement wealth. People “feel like they have to pay off the house before they retire,” says Mork. “That’s not always the case.”
How one expert made the decision
Morgan Housel is a Wall Street pro and author of the book “The Psychology of Money.” Housel and his wife carry no mortgage on their home — a money move he acknowledges is irrational.
“On paper, it’s the dumbest thing you could possibly do,” says Housel. “Even though it’s the worst financial decision we’ve ever made, I [also] think it’s the best money decision we’ve ever made. It’s one thing that gives us a level of independence and autonomy.”
Housel admits they didn’t behave logically on this front — but that sometimes peace of mind wins out. He and his wife actually celebrated when they paid off their mortgage. “When we did it, it was like, high five, hug each other, this is so cool,” says Housel.
The lesson, he says: Maximizing every penny of returns can be emotionally exhausting.
“People should not just aim to be rational on a spreadsheet — ‘rational on paper,’ I think, is not a good financial goal,” says Housel. “People should aim to be reasonable and manage their own financial decisions about what makes them happy, and what helps them sleep at night.”
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