Pay Off Mortgage or Invest

Should You Pay Off Your Mortgage or Invest?

Among the many debates that rage in the world of finance, there’s one that stands out from the crowd is should you pay off your mortgage or invest.

It’s a good question and one that’s particularly relevant to the estimated 82.8 million owner-occupied households in the US. After all, for most people, their mortgage is the most significant debt they’ll ever have to pay.

Of course, paying off your mortgage and investing your hard-earned money are both commendable goals. But is one better than the other? Which pursuit makes sounder financial sense? In this article, we’ll dive into the issue.

Read on to discover whether to pay off your mortgage or invest.


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The Conflict

Common sense suggests paying off your debt should be the priority. Why?

In part, because it simply doesn’t feel good to owe money (it’s called a burden of debt for a reason)! Indeed, approximately 40% of individuals with bad credit card debt say it impacts their happiness and 20% say it harms their health. Interest makes it more expensive as time passes too, and there’s always the risk of defaulting if you go through a difficult financial period.

Furthermore, is investing even worthwhile when you’re paying interest on the loan? For your bank balance to benefit, you have to ensure the return on investment (ROI) exceeds your mortgage rate over time. That seems probable in periods of economic growth, but with rising inflation, the war in Ukraine, and an economy reeling from years of COVID-19, it may seem less likely in the current climate.

On the other hand, it’s common knowledge that wealthy people invest. To paraphrase a famous saying, “the poor spend their money, the middle class save it, and the rich invests”. With financial pundits heralding the virtues of investing (for good reason), it’s natural to assume it eclipses the virtues of paying off your mortgage instead.

Sean Polley, CWM® of Polley Wealth Management agrees and says,

“Mathematically, it can make more sense to not pay off the mortgage and invest your money. However, some people struggle with the discipline of investing. If you can stick with the investment process when the numbers make sense, do it.  If you struggle sleeping at night because you have a mortgage, pay off your mortgage.”

The First Impression

Nevertheless, after a quick look at the current interest rates and the average return of the S&P 500 Index, you’d be forgiven for thinking the debate’s a no-brainer.

Although mortgage rates climbed to 5% recently (for the first time in 10 years), they remain incredibly low from a historical perspective. At the same time, the S&P 500 Index, which acts as a benchmark for the US stock market as a whole has delivered an average annual return of 10.7% over the last 65 years.

Most people would take that extra 5.7% in a heartbeat. Surely, then, savvy homeowners are better off paying the minimum on their mortgages and investing whatever’s left in stocks?

Perhaps. In many (if not most) cases, this could be the best approach.

Yet first impressions can be misleading and nothing (especially in the complicated field of finance) is straightforward. In reality, there are other factors to consider that may determine the right approach for you.

The Considerations

If you’re struggling to decide whether to pay off your mortgage or invest, taking the following factors into account should help:

Retirement

Investing tends to be the right call for people who are decades away from retirement. The more time you have between now and your golden years, the easier the decision becomes.

This is because of the opportunity cost involved with servicing debt. Remember, the stock market has delivered enviable average returns throughout history. While it may deliver less than your mortgage rate over a matter of weeks, it’s almost guaranteed to outperform it over 10+ years.

In essence, you leave money on the table by choosing to pay off your mortgage assuming the interest rate’s manageable. And make no mistake, it’s no small sum either. Thanks to the magic of compound interest, an initial investment of $10,000, plus a monthly contribution of $500, can turn into $284,669.80 over the course of 20 years assuming a relatively conservative average return of 7%.

Liquidity

Access to capital is another important consideration here. Needless to say, you can’t eat your house! While paying off your mortgage sooner will alleviate the stressful nature of having debt, you risk tying up your cash in the property. Although renting it to tenants, selling it, or taking out a loan against your equity are viable options, accessing that money becomes a challenge.

Despite the fees and tax implications involved, invested money has much higher liquidity. Whenever you want spendable cash, you can simply sell as much or as little of your holdings as required.

Rates and Risk Tolerance

Investing isn’t right for everyone though. For instance, while the average rates in the US remain low, you might be encumbered with an expensive high-interest mortgage. Not only would this detract from stock market returns, but it may also dominate your monthly cash flow, leaving very little left to invest anyway.

Then, of course, there’s risk to consider. Younger people have time on their side, which allows for market corrections and minimizes the risk of downturns. The same can’t be said for shorter time frames.

Ultimately, if you’re much closer to retirement age, then the argument to invest becomes weaker. Less time in the market makes you a) more susceptible to variation and b) unlikely to recover from a bear market.

That’s not all, either. Having to repay a mortgage on a post-retirement fixed income is far from ideal. In the lead up to retirement, then, it’s often sensible to devote more of your excess cash to the mortgage.

Pay Off Mortgage or Invest? You Decide

Deciding whether to pay off the mortgage or invest is a common conundrum faced by homeowners everywhere. In general, the higher returns offered by the stock market trump the money you’ll save from repaying your mortgage sooner. As we’ve seen, though, there are pros and cons on both sides, with individual circumstances featuring heavily in what constitutes the “right” decision.

With any luck, the insights in this discussion will help you choose the path that makes the most sense for your financial situation. 

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Danny Newman is a digital nomad, blogger, and content writer from the UK. A passionate traveler with a perpetual itch in his feet, he’s always on the hunt for the next big adventure.

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