Most people have to be deliberate with how they spend their money and, for the vast majority, that means making a decision between paying down debt or investing in the future. If you’re wondering whether to payoff a mortgage or invest, you’re not alone. We’ll walk you through what you need to consider before making the decision, including the pros and cons of each choice and a look at how both options play out by the numbers.
Paying off your mortgage early
The idea of owning your home outright and being debt-free is very enticing, which is why many people consider paying off their mortgage early. Particularly, if you’ve started earning more money since you first bought your own home, it may be a good idea to put some extra money into your mortgage payment each month. Still, there are benefits and drawbacks to consider before making your decision.
The benefits of paying off your mortgage early
- You’ll save on interest: Particularly if you start paying down your mortgage in the early years of your loan, you stand to save money on interest payments by reducing the principal amount that you owe.
- You’ll build equity: Paying down your mortgage also helps you build up equity in your home. Once you have enough equity, you can leverage it to help you cover any big expenses that may crop up in the future.
- You’ll help your credit score: The amount of debt you have to your name impacts your credit score. Paying down your mortgage will reduce your total amount of debt and help to boost your overall score.
The drawbacks of paying off your mortgage early
- You may hinder your other financial goals: If the majority of your extra cash is going toward making bigger mortgage payments, you may not be able to keep up with other personal finance goals, such as retirement planning or building an emergency fund.
- You’ll tie up your wealth: Unfortunately, real estate is a fairly illiquid investment, meaning you won’t be able to access any built-up wealth very quickly. If you had an emergency and needed funds, you would need to market your home, find a mortgage buyer, and go through the settlement process before you could access any profits.
- You’ll forgo the tax break: Mortgage interest is tax-deductible. However, once you pay off your home, you’ll no longer qualify for that deduction. Plus, there’s a good chance that your retirement account is tax-advantaged. If you can’t afford to contribute to your retirement savings while paying down your home loan, you’ll be missing out on that tax break as well.
Investing in the stock market
Now, it’s time to look at the flip side of whether to pay off a mortgage early or invest. After all, investing in stocks or other investment vehicles is a primary strategy for building wealth. Still, as with paying down your home loan, there are both benefits and drawbacks to investing. We’ve laid them out for your consideration below.
Benefits of investing in the stock market
- You may earn higher returns: While there are no guarantees in investing, stocks tend to have higher rates of return than mortgages. For example, according to the SEC, stocks have historically provided a 10% annual return. Meanwhile, according to Freddie Mac, mortgage rates have remained under 10% since the late 1980s.
- You’ll have a liquid investment: While investing in real estate will tie up your wealth for the long term, stocks can generally be sold fairly quickly, which means that you will have access to funds when you need them.
- You may have the option of an employer match: Depending on your financial situation, you may be in the position to have your employer match any funds that you add to your retirement account. If that’s the case, making larger contributions will lead to more money earning compound interest and will help you build your wealth over time.
Drawbacks of investing in the stock market
- You’ll take on more risk: It’s also true that there is more volatility in the stock market than in the housing market. If you’re going to go this route, you’ll need to ensure that you’re investing in a portfolio that suits your level of risk tolerance and that you’re mentally prepared to weather a few ups and downs along the way.
- You will still have debts: Unfortunately, while investing in the stock market can help you to build wealth, it won’t help you to become debt-free overnight. If you want the peace of mind of knowing that you own your home outright, investing may not be your first choice.
By the numbers: is it better to pay off my mortgage or invest?
To really see whether it’s better to pay off a mortgage or invest, let’s look at the numbers. For instance, let’s say you have a $250,000 30-year, fixed-rate loan at a 4.0% interest rate. If you were to pay the loan as prescribed, you would pay a total of $179,890 in interest over the life of the loan. However, if you were to pay off the loan ten years early, you would only pay $113,063 in interest and would achieve a savings of $66,820.
Why that number may seem sizable, let’s compare that to the stock market. If you invest an initial $100 and an additional $200 per month after that, if it has an 8% annual return – which is lower than the historical average of 10% – you will have made $118,297 at the end of the same 20-year period. That figure far outstrips the $66,820 in mortgage interest saved.
How to decide to pay off your house or invest
If money is the driving force behind your decision to pay off your mortgage early or invest, then you have your answer. However, for many people, this decision is not quite so black and white. There are other factors to consider, including:
- Evaluate your risk tolerance: Put simply, the stock market is going to have ups and downs. If you don’t have a long investment timeline or you’re very risk-averse, you may want to consider paying down your mortgage which is a surer bet.
- Consider your other financial goals: Similarly, if you have other goals, such as paying down high-interest debt, or building an emergency fund, you may want to think about using a portion of your extra cash to work towards those goals as well.
The bottom line on paying off your mortgage vs. investing
Ultimately, the decision to invest or pay off a mortgage is a personal one. It’s important to look at the specifics of your financial situation, your financial goals, and your investment tolerance before making your decision. With that in mind, use the information in this post as a guide to get you started on weighing all of your options and making the decision that feels like it makes the most sense for you.
Cited article sources
- FreddieMac: “30-Year Fixed-Rate Mortgages Since 1971” https://www.freddiemac.com/pmms/pmms30
- U.S. Securities and Exchange Commission Office of Investor Education and Advocacy: “Saving and Investing. A Roadmap to Your Financial Security Through Saving and Investing” https://www.sec.gov/investor/pubs/sec-guide-to-savings-and-investing.pdf