should i pay off mortgage early

Million Dollar Question: Pay Off Your Mortgage Early or Invest More Now?

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A tough decision many homeowners face is to either pay off the mortgage early, or invest. They might decide to invest more towards stocks, bonds, mutual funds, or towards your retirement savings.

The tradeoff comes down to reaching debt freedom sooner, or having a larger investment portfolio when you retire.

The million dollar question becomes:

Should I pay down the mortgage faster or invest more in the market?

Advantages of Paying Your Mortgage Early

Absolute Debt Freedom

The largest advantage of paying down your mortgage early is you own your house sooner. Paying off your mortgage (or any loan) early means you save tens of thousands of dollars in interest. To see what this looks like for you, you can enter in your own mortgage stats into this mortgage calculator and see how much you can save by contributing an extra amount each month. Even as little as $100 extra every month, is still quite a bit of savings over the life of your loan.

Bonus: If you didn’t have enough to make the 20% down payment when purchasing your home, extra payments will also help eliminate your private mortgage insurance earlier, and therefore save thousands of dollars in insurance premiums you are paying to the bank to protect the bank from….well…..you.

The Peace of Mind

What’s one of the largest recurring expenses in your life?

Your mortgage payment.

Once you pay off the mortgage, you can take that monthly payment and redirect it towards your investments. Obviously you did miss out on compound interest while paying down your mortgage, but remember you also saved a bunch of money by eliminating the interest paid on your loan early.

And don’t forget once you pay off your mortgage, you will no longer have the ability to deduct the mortgage interest come tax time. However, more than likely you are better off with the savings in interest versus any tax savings you get from the mortgage tax deduction.

Here’s an Example:

Let’s pretend you earn $50,000 per year and you owe $200,000 on your mortgage at 4.5 percent interest. Therefore you would pay roughly $9,000 in mortgage interest and would then deduct that amount from your taxable income. The result is instead of getting taxed on $50,000 this year, you would only be taxed on $41,000.

This puts you in the 25 percent tax bracket and since you lowered your taxable income by $9,000 with the deduction from the mortgage interest, you will save $2,250 come tax time.

However, once your house is paid off this deduction goes away, which is why the majority of people think it’s a good idea to keep your mortgage for the deduction.

Why are they wrong?

Yes, it’s true you are losing out on the tax deduction by paying off your mortgage earlier. But, you are also avoiding paying any mortgage interest as well. The result is you are now paying the government $2,250 versus paying the bank $9,000.

Here’s another way to think about it: You have the choice to owe Sam $2,250 or owe Bob $9,000. I think it makes sense to pay Sam and save, invest, or do whatever you want with the money you didn’t pay Bob 🙂

Reminder: You must itemize your taxes if you plan on deducting your mortgage interest.

Disadvantages of Paying Your Mortgage Early

Can You Afford an Emergency?

It can be real easy to raid your emergency fund or divert savings to pay off your mortgage early. If an unexpected event happens such as losing your job or getting hospitalized, you might have to pull from your emergency fund to pay your bills. Investments however can be sold off instantly (non-retirement investments) which gives you immediate access to cash when you need it.

If the majority of your money is in the equity in your house, you potentially could end up having to take out a loan against your home to pay the bills. Therefore, it’s imperative to have an emergency fund before you start making any extra mortgage payments or investments.

Don’t Maximize Your Peak Investing Years

The #1 investing secret is time.

It’s what allows a 20-year old who invests less overall to retire with more than somebody waiting until their 30s to start investing. By making extra mortgage payments, you might not have as much money as you would if you invested more in your younger years.

Utilize this Investment Calculator to see how much your investments can grow over time. Then compare that amount to how much money you can save in interest by making extra mortgage payments to help you make your decision.

Advantages of Making Extra Investments

Overall Market Returns Are Higher Than Mortgage Interest Rates

The current national average 30-year fixed mortgage rate is approximately 3.84%. If you had invested in the S&P 500 for the previous 5 years, your average annual return would have been 5.54%. That’s almost 2% more each year your money can earn. And, if the market performs better in the upcoming years, the income potential gets even higher by investing your extra income.

Let’s do some quick math comparing how much money you can save in interest or earn from investments.

Extra Mortgage Payments

Your minimum monthly payment (principal and interest) will be $1,170 for a $250,000 30-year fixed rate mortgage with a 3.84% interest rate. Did you know you will pay approximately $171,000 in interest if you take all 30 years to pay the mortgage? Ouch!

However, by making one extra half mortgage payment each month ($1,755 monthly payment versus $1,170 monthly payment), your house will be paid off 14 years earlier and you will save $87,000 in interest!

Extra Investments

What if instead of making the extra half payment each month, you decide to make the minimum mortgage payment and invest that same amount instead?

If you invest the additional $585 payment every year for 14 years (the time it would take to pay off your mortgage with the added monthly amount), you will have $178,997 in the end.

This amount is determined from the $98,865 you invested and the $80,132 in interest assuming a eight percent annual rate of return.

In this example, it appears the extra investments would return $80,132 while the same amount applied to your mortgage will save you $87,000.

Keep this in mind the RISK factor.

The interest rate on your mortgage is locked if you have a fixed rate mortgage. On the other hand, there are no guarantees with investing. We hope, pray, and assume we earn an eight percent annual return over 14 years, but we can’t guarantee it.

Here’s the same example above with an investment rate of return of:

Two percent: $15,246

Four percent: $33,326

Six percent: $54,741

Eight percent: $80,132

Ten percent: $110,241

Takeaway: You must calculate the RISK factor

Potentially Maximize 401k & IRA Contributions

By making extra monthly investments, you have the ability to max out your IRA & 401k contributions. Currently the annual maximums (2017) are $5,500 for IRAs and $18,000 for 401k plans. This means you are not only earning compound interest (passive income) but more of it is saved in tax-favored accounts. By waiting to invest, any extra investments might be fully taxable if you have already maxed out your retirement accounts for the year.

Related: What in the World is a ROTH IRA?

Disadvantages of Making Extra Investments

The Markets Could Tank

If the stock market enters a bear market (slow moving and downward market), your investments might actually lose money for a few years. Not only do you lose money, but don’t forget you still have a monthly mortgage payment to make. History tells us the markets will move up and down in a cyclical fashion, but once your mortgage is gone, you are free from the stress of making a mortgage payment in a bear market with a down economy.

You Still Have Debt

Making extra investments can be a wise long-term financial move. Especially if you can still retire debt-free and afford to retire on time. However, some people just simply hate remaining in debt & having to make yet another monthly payment for the next 15 to 30 years. If you want the peace of mind, making extra mortgage payments today means a lower cost of living sooner than later.

What Should You Do?

Deciding to make extra mortgage payments or invest in the market depends on several factors including your current income and debts, tolerance for debt, and your short-term and long-term financial vision.

Extra Mortgage Payments

It is better to make extra mortgage payments when:

  • You want to become debt-free as quickly as possible
  • Most of your current paycheck goes to monthly loan payments (credit cards, car loans, house)
  • You are already meeting your employer 401k match and/or saving at least 15% for retirement and plan to make extra investments once your mortgage is paid off.

As you are already in the mindset of making extra mortgage payments, use that money to make extra investments once you pay off the mortgage.

Extra Investments

You might pursue extra investments if:

  • You view your current mortgage rate as “cheap money” because the stock market will yield a higher amount over the life of your mortgage.
  • Want to keep your disposable income “liquid” as investments can be sold almost immediately while your house can sit on the market for months.

Nobody can predict the performance of the investment markets. If you don’t plan on using the extra investment money in the next five years, you can potentially earn more money than the interest you will pay on a 15-year or 30-year mortgage. You will have higher monthly expenses for a longer timeframe but you may have a larger net worth in retirement.

Summary

If you decide to make extra mortgage payments, make sure you don’t stop investing altogether. Your first priority should be getting out of debt as soon as possible, but also take advantage of your employer retirement benefits such as matching 401k contributions or even contributing $100 a month to a Roth IRA. The bottom line is you still need to plan for the future.

Extra investments, in lieu of extra mortgage payments, will set you up for financial security in the coming decades. But, you can’t ignore the risk factor. There is an old saying in investing from Mark Twain that goes:

October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.

There will never be a black and white answer when it comes to the million dollar question of mortgage versus investing. The bottom line is to simply understand how to get to your own answer based on your life and your money.

Good luck!


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18 replies
  1. Maria
    Maria says:

    I agree with pay off the mortgage faster. There are many factors though, and that doesn’t make sense for everyone. For us, hubby works away and I’m home with the kids. We are “socking it to” the mortgage as much as we can so he can move back home permanently. If he moved back now, due to the depressed earnings in our area, I would have to go back to work, and neither of us wants that. Therefore, when he does move back the loss of the mortgage interest deduction will coincide with a reduction of income and in turn, we will be taxed less while not having enough deductions to itemize anymore and just take the standard deduction. But, either way you go, pick one. Because ulitmately if you do nothing you’ll be working far too much into your future!

    Reply
    • Chris Peach
      Chris Peach says:

      It sounds like you guys have put a lot of thought into it to make sure you are making the best decision for your family. I totally agree that you need to do one or the other, otherwise you’re just wasting time and money. 🙂

      Reply
  2. Andrew Breidenbaugh
    Andrew Breidenbaugh says:

    Good article. The other thing to keep in mind with regard to paying off the mortgage interest is you still have the standard deduction. Keeping the mortgage means you have itemized deductions of $9,000 (assuming no other deductions). Paying off the mortgage means you still have the standard deduction of $6,350.

    Reply
  3. Brian - Rental Mindset
    Brian - Rental Mindset says:

    Looks like there is a typo – the S&P has returned way more that 5% a year over the last 5. It has just about doubled in that time, so without calculating yearly, something like 15%?

    The thing I warn people about making extra mortgage payments – now that money really isn’t accessible. Say you lose your job and can no longer make even the lowest mortgage payment. They are going to take your house, even if you only owe 20% left on the loan. Someone who owes 50% left on the loan, but was socking that money away into the stock market or elsewhere? They will be able to sell those other assets and keep making minimum payments. So I’m in the camp: save up and pay off the mortgage all at once (if you want).

    Reply
    • Chris Peach
      Chris Peach says:

      Hi Brian, thanks for pointing that out. I will take a look and make sure we get any typo corrected. 🙂 That’s definitely something to consider. Now keep in mind that depending on the investment, there could be huge repercussions for withdrawing the money, making it nearly inaccessible anyway.

      Reply
  4. Jorge Saladas
    Jorge Saladas says:

    The biggest tool to create wealth is your income. You should pay off your house and any debt as fast as you can.

    Reply
  5. Daniel
    Daniel says:

    So in the end it really comes down to personal risk preference. So many of the Ramsey-ites have a black/white view of debt (in particular good debt, which they would argue doesn’t exist), but it really comes down to your personal taste for risk and asset allocation (I personally only do paydowns when my house drops below 20% of my net worth, personal housing is traditionally the worst performing and least liquid of any asset that you will ever own).

    Reply
  6. Michael Arroyo
    Michael Arroyo says:

    #1 never never never have a credit card balance. Starve before getting a finance charge Always pay off your credit card entirely every month. Then focus on your mortgage and investments

    Reply
  7. Stephanie Parnell
    Stephanie Parnell says:

    Wow! Great information with great perspectives. These are exactly the questions I have been thinking about for months!! I’m 33, got an emergency fund in place, save 15% in retirement accounts & have a mortgage. (never had a credit card) I am definitely going to save the amount I need to pay off my house in 10Years

    BUT ( how i do that is the question) …….. i really want that money in a short term investing account. This way I can use it to purchase 10 acres to build my forever home on when that perfect property pops up in the meantime.

    This is my thought process who knows if it will change. LOL

    Reply
    • Chris Peach
      Chris Peach says:

      Short term investments might be a good option for that savings, but don’t forget that they are still not as liquid because you might have to pay fees if you try to get out of investments early if/when the property comes up for sale.

      Reply
  8. Anna
    Anna says:

    I agree that it is important to pay off your mortgage as soon as you can. Having a nice nest egg in the bank can be really nice. However, paying off your house is far more important, because once your home is paid off you can look forward to saving the money you would have been putting on your mortgage and instead of putting that money in the bank for retirement and other purposes.

    Reply
  9. Tyler
    Tyler says:

    One thing to consider. (I am a Dave Ramsey guy so I don’t like debt, but as a business owner I am always looking at return on investment). Per your calculations you would save more in interest then what you would get from investing that money. But in reality the way we should look at this is if you had to cash out at any point in time what method would yield you the most amount of savings+return (or cash). Even though the house would have saved you 87k in interest. Your true value after the fact (because the house is paid off) would be whatever the house is worth. Lets say 250k (original purchase price). With the investment you would have about 80k in retained earnings and a total of 170k (ish) after 14 years. But what about the Equity you built in those 14 years making regular payments? That is another factor you must consider. Since you are comparing two methods you must look at what your total net would be if you cashed out at any time from both. Then factor in what kind of risk you want on your investment portfolio.

    Reply
  10. Tyler
    Tyler says:

    Did anyone else catch the the investment should be calculated over 16 years not 14 because the house was paid off in 16 years not 14. So if you want a direct comparison on the growth of that investment in relation to the savings on the mortgage you would have to do them over the same exact time period.

    Reply

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