How To Decide Whether To Pay Down The Mortgage Or Invest

For many, a mortgage is the largest amount of debt they hold. Especially for those who have very little other debt, it can be natural to think about paying down your mortgage to become totally debt-free. While that can make sense in some situations, another school of thought suggests you keep paying your mortgage and use excess money to invest in the stock market instead.

Paying off your mortgage sooner

There are valid reasons to be aggressive about paying off your mortgage as soon as possible, but the decision ultimately depends on your goals and tolerance for risk.

Say you bought a house with a $320,000 mortgage, a 30-year fixed-rate loan at 4 percent with monthly principal and interest payments of $1,528. After five years, you decide to accelerate your payments:

Additional payment Payments total Savings Payoff time
$0/month ($1,528) $549,982 $0 30 years
$100/month ($1,628) $531,018 $18,964 2 years, 6 months sooner
$200/month ($1,728) $516,025 $33,957 4 years, 6 months sooner
$300/month ($1,828) $503,845 $46,138 6 years, 2 months sooner

Paying additional each month towards your principal can drastically reduce the amount you’ll pay, as well as how long it’ll take to pay things off. You can use Bankrate’s mortgage payoff calculator to estimate different payoff scenarios.

Investing in the market

Instead of diverting extra money to a monthly mortgage payment, you might choose to route those funds to investments. To illustrate the other side, let’s continue our earlier example and say you invest an extra $200 each month over 25 years.

Rate of return Investment total Gains
2% $74,980 $14,980
5% $106,312 $46,312
7% $135,770 $75,770
10% $198,906 $138,906

You can use Bankrate’s return on investment (ROI) calculator to estimate gains based on various rates of return and levels of investment.

Mortgage payoff savings vs. potential investment returns

As you can see from these examples, it doesn’t take a very high return for your investment gains to overtake the savings from paying off your mortgage. Even a return of 5 percent — lower than the historical average for the stock market — would generate more than the savings from a mortgage payoff.

Strictly looking at the numbers, it might seem like investing is the way to go. Both strategies are correct in theory, says Ken H. Johnson, a housing economist at Florida Atlantic University. Using debt as leverage to boost returns is a common practice in the financial world. On the other hand, there’s much to be said for the cozy feeling created by an utter lack of creditors seeking monthly payments.

“You can’t go broke if you don’t have any debt,” Johnson says.

Which approach is right for you really depends on how you feel about debt and how comfortable you are with the market’s inevitable swings. Paying off your mortgage is generally more risk-averse, while investing can be right for someone who is more tolerant of risk.

On top of that, home mortgage interest is tax-deductible, so many prefer to invest their money rather than use it to pay down mortgage debt. Of course, if you choose to pay down your mortgage, however, it’s not as easy to access those funds.

Alternatives for your money

Before investing extra money or paying down your mortgage, make sure you have an adequate emergency fund with several months’ worth of savings. If you have credit card balances, work to pay those down, too — while a mortgage is a type of debt, it’s generally considered “good” compared to credit card debt.

If you’ve established an emergency fund and don’t have high-interest debt, another option to consider if you have significant equity in your home is to refinance your mortgage with cash out and invest in the stock market or another vehicle with the potential for higher returns.

Bottom line

The better choice between paying off your mortgage or investing those extra funds isn’t clear-cut, and can be driven by your financial goals, personal preference and appetite for risk. Running the numbers, investing has the potential for higher returns, but ultimately, either path can be the right one depending on your circumstances.

With additional reporting by Jeff Ostrowski

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