Have you recently received a bonus? How about a cash windfall?
If you have extra money burning a hole in your pocket, you may be debating whether it’s a smarter financial strategy to pay off your mortgage or invest.
Generally speaking, growing your wealth with investments can yield a better long-term result than reducing low-interest debt. However, determining the right course of action depends on your financial situation. In this post, we’ll discuss the pros and cons of either option so you can judge accordingly.
Paying off Mortgage vs Investing
Just like “to be or not to be,” “to pay down mortgage or invest?” is a classic question. Your natural inclination may be to pay off your mortgage before investing money elsewhere.
The amount you owe might be an incredibly large sum, the idea of which weighs on you. So, on the surface, it makes sense to chip away at that debt.
But the decision isn’t as simple as that. There are various matters you must consider about your specific mortgage contract and your financial situation.
Questions you should first ask include:
- How much is your monthly mortgage payment?
- What is the mortgage interest rate on your loan?
- How much money do you already have invested?
- How far into your mortgage are you?
- What is your financial situation?
- Do you have other debts?
- How close are you to retirement?
If your current mortgage loan payments are affordable or you’re well into your mortgage term, investing might be a better option.
To understand, we need to first discuss the basic economics of a mortgage.
A mortgage loan enables an individual or family to purchase a home with money they do not yet have. In most cases, a loan term will be between 20 to 30 years.
After the loan documentation is completed, the borrower agrees to pay back the mortgage lender via monthly payment installments until the loan and its interest is paid off. The lender agrees to pay for the entirety of the home’s selling price in exchange for interest on the balance as well as repayment.
To crunch the numbers on your own debt, you need to consider two factors:
- Principal and interest – Payments are split into the interest on the total loan and payments on the principal amount.
- Amortization schedule – This is the entire interest payment schedule. Most mortgages will be set up so that the majority of initial payments are devoted to paying off interest. Then, down the line, more of the payment goes towards the principal.
Depending on your loan, you can run a debt amortization calculator to see how much more money you’ll be paying over the amortization lifetime. Generally speaking, if you can pay it off early, you can save thousands, if not tens of thousands, that would otherwise be spent on interest since contracts tend to frontload interest payment.
If you’re nearing the end of your loan, there’s actually less incentive to pay it off earlier than necessary. In contrast, if you’re in the early stages of your loan, you could wipe away a significant chunk of would-be interest by making a large mortgage payment now. Furthermore, there are many ways on how to lower mortgage payment without refinancing.
Advantages of Paying Off Your Mortgage
Is it better to pay off the mortgage or invest? It all depends on your short-term and long-term financial goals.
There are several reasons why a person might want to pay off their mortgage early. These include:
- Being debt-free – For some, the burden of debt can be overwhelming. Failure to pay your mortgage could cause you to lose your house to foreclosure. So you might prefer having peace of mind and financial security knowing that you’re finally debt-free. That’s a huge financial milestone.
- Interest savings – Paying more of your mortgage back early can shave tens of thousands of dollars that would otherwise be spent on paying interest. This also speeds up the loan duration, for those wondering how to get out of a mortgage quicker and pay less doing so.
- Increase your equity – As payments shift more towards the principal and away from interest, you increasingly gain more equity on your home. If need be, this equity can then be later leveraged using a home equity loan or home equity line of credit (HELOC) to free up cash.
- Save and invest more down the line – Once you no longer have massive loan payments in your monthly budget, you can devote all of those funds towards savings and investment.
Disadvantages of Paying off Your Mortgage
Naturally, there are also reasons why paying off your mortgage early may not be the best decision for your situation. These include:
- Opportunity cost – By devoting money to paying off your mortgage instead of investing, you miss out on potential earnings that could potentially far outweigh the interest amount saved.
- Less disposable money – When a significant portion of your budget is spent on paying back your loan, you’ll have less money to spend or set aside for a rainy day. This means your retirement and emergency savings will be emptier.
- No tax breaks – Most homeowners can benefit from a mortgage interest tax deduction. But if you pay it off early, you won’t be able to claim that deduction any longer.
Investing vs. Paying Off Mortgage
In most cases, it will be better to invest your money instead of paying off the mortgage early.
Why is that?
Put simply, if you were to invest $100,000 dollars today instead of putting that towards your loan, the market on average would dramatically outperform the potential savings you’d make on future mortgage payments. And that’s regardless of whether you have a low or high risk tolerance. For instance:
- For a low risk tolerance – Simply investing in a diversified stock portfolio is one of the safest ways to earn interest on investment. According to Goldman Sachs, over the past century and a half, the 10-year stock market returns have averaged 9.2%.
- For high risk tolerance – From 2011 to 2020, Bitcoin—the blue-chip stock of the cryptocurrency market—has delivered an annual average return of 891%. Similarly, Ethereum—Bitcoin’s heir apparent—has experienced a mean annual return of 2383% over the past five years.
And there are dozens of potential investment opportunities outside of cryptocurrency and the stock market. For instance, there are commodities like gold and silver, which have both averaged approximately 10%–15% returns over the last 50 years.
You could also use your extra cash to invest in something personally significant, whether your own business or a set of prized antiques.
Advantages of Investing vs. Paying off Your Mortgage
Common reasons why it may be more advantageous to invest include:
- Higher rate of return – The earlier you invest, the longer you’ll be able to enjoy compounding interest. And, since investing is inherently more risky, it provides the potential to garner higher returns.
- Low interest rates – If interest rates are low, it actually may be wiser to refinance your mortgage and then invest more aggressively since the market’s expected rate of return will be higher than the interest payments.
- Increased liquidity – Outside of retirement, many retail investments aren’t fixed. That means you can sell them instantly if you need access to cash.
- Employer matching and tax savings – Investing in a 401k often comes with additional benefits such as employer matching. Additionally, certain savings accounts allow you to invest and then eventually withdraw the money without any tax penalty.
Disadvantages of Investing vs. Paying off Your Mortgage
While investing is a great solution, it’s not always possible if your current mortgage payments are higher than you can comfortably afford.
Drawbacks to investing instead of putting the money towards your mortgage include:
- The mortgage takes longer to pay off – If you’re unable to make early payments, you may end up having to pay for your mortgage for the full 20–30 year term, which keeps you in debt longer.
- More interest – You’ll have to pay more interest on the loan than you otherwise would have if you paid it off earlier.
- Increased risk – When considering whether to pay mortgage or invest, consider your own risk tolerance. The stock market can be volatile. Yes, there is more upside, but potentially far greater risk of losing your money.
Sale-Leasebacks to Help You Invest
Should I pay off my mortgage or invest? There’s an easy answer—with interest rates at historic lows and investment markets booming, for most parties, investing extra money instead of paying off your mortgage is likely the smartest financial decision.
And with a Sale-Leaseback, you can get access to additional cash so that you can invest and plan for retirement.
A sale-leaseback enables you to convert your home equity into cash with home equity loan alternative solutions based on your individual goals—whether that includes downsizing to a new home or staying put for the foreseeable future.
Start by selling your home, converting your home equity to cash, and leasing your home back. With the cash from your home equity, your mortgage gets paid off and you get the rest of the cash to figure out your next steps without the hassle and rush of moving out.
If you have extra money burning a hole in your pocket, you may be debating whether it’s a smarter financial strategy to pay off your mortgage or invest. If you are still unsure of smart financial strategies, after reading this article, consult a financial advisor to discuss your options.
- Investopedia. Should I Invest or Pay off My Mortgage? https://www.investopedia.com/ask/answers/05/052205.asp
- S&P Global. S & P 500 returns to halve in the coming decade – Goldman Sachs. https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/s-p-500-returns-to-halve-in-coming-decade-8211-goldman-sachs-59439981
- Coindesk. Should You Invest in Bitcoin for Retirement? https://www.coindesk.com/learn/2021/08/24/should-you-invest-in-bitcoin-for-retirement/
- Statista. Average Annual Return of Gold. https://www.statista.com/statistics/1061434/gold-other-assets-average-annual-returns-global/