At a Glance
If you own a home, your mortgage payment likely consumes a large amount of your monthly budget. And regardless whether you have a 15-year, 20-year or 30-year mortgage, one of your goals may be to pay off your mortgage early, especially since paying off debt has its advantages and can help you reach your financial goals faster.
However, current low mortgage rates may make it tempting to put more of your budget toward investing instead, increasing your returns at a higher rate. So the question is, should you pay off your mortgage early, or invest?
Deciding whether to put extra funds toward paying off your mortgage early or toward investing depends on your personal financial goals and individual situation.
In this article, you’ll learn:
Is it better to pay off your mortgage or invest?
If you have extra funds, deciding whether you should pay off your mortgage vs. investing comes down to factors such as your monthly mortgage payment, the term of your loan, your interest rate, and your financial goals.
Here’s an example of how you can decide. Using mortgage rates from December 2021, here are some estimated calculations for a 30-year loan term:
|Total Interest Paid
|Total Time to Pay Off
Now, say you have an extra $300 per month to pay toward your mortgage.
|Total Interest Paid
|Months of Payments Saved
By putting an extra $300 per month toward your mortgage, you’ll save $52,234.22 and 99 months of payments (or 8 years and 3 months). If you’re able to put more than $300 extra per month, you can save even more. For example, putting $500 per month extra toward your remortgage will save you $72,154.16 and 138 months of payment (11 years and 6 months).
You can use an amortization schedule calculator to help you estimate savings for your personal situation.
Now, imagine that you invested that $300 instead. How much you can potentially make depends on the type of investment you’re interested in. For this example, let’s say you’ll invest $300 per month into an index fund tied to the Dow for the next 15 years. According to Macro Trends, the Dow Jones Industrial Average has returned an average of 7.5% return per year, and for this example, we’ll use a 4% variance in either direction.
In 15 years, you could have nearly $95,000 (depending on the variance, knowing there will be years where the stock market will net you losses, and other years where you’ll net gains). You can use a compound interest calculator to estimate how much your money can grow.
However, keep in mind there are many different types of investments, such as retirement accounts, stocks, bonds, IRAs, and more. Each has different levels of risk and potential for earnings, so carefully consider which you’re comfortable with and weigh the pros and cons.
Compared to the savings of $52,234.22 by putting that $300 per month toward a mortgage, in this case, it may seem to make more sense to invest. But again, there are always caveats depending on your own situation. It may be helpful to talk to a financial advisor before making any decisions.
Pros and cons of paying off your mortgage
- Equity. Paying off your mortgage helps you grow equity, especially if you’re putting more than your minimum payment toward the balance each month. This can specifically make refinancing easier.
- Decreasing debt. Not all debt is necessarily bad, but decreasing how much debt you owe can help lower your debt-to-income (DTI) ratio, which is important when it comes to loan qualification. If you need another loan, lower DTI can help you get approved more easily.
- Lower interest. Because your DTI is lower and you’re building equity, you may qualify for lower interest rates on other loans or financing.
- Frees up funds. Once your mortgage is paid off, you can put those dollars to other things, such as savings, retirement, an emergency fund, or even fun things like a vacation.
- Slower investment growth. Because you’re putting your extra funds toward paying off your mortgage, you aren’t investing those dollars for growth. This can make reaching your financial goals more difficult or take longer.
- No tax deductions. As a homeowner, you may take advantage of the home mortgage interest tax deduction. By paying down your mortgage faster, you’re reducing the benefits of this deduction.
- Penalties. Some loans have prepayment penalties, which are fees you’ll incur for paying off your mortgage faster or in full before the term is up. Read the terms of your loan carefully before making extra payments to make sure you won’t have these charges.
- Small savings. If you’re nearing the end of your loan term, you’re likely paying more toward the principal balance and less on interest. Making larger payments will help pay off your mortgage faster, but you won’t be saving nearly as much on interest. It may be better to invest in this case.
Pros and cons of investing
- Faster growth. Current mortgage rates are very low compared to average, so you aren’t paying as much in interest as you would in past years. This savings could be invested to grow those funds faster.
- Compound interest. Your investments can grow exponentially over time due to compound interest. This means you can earn the percentage of interest on whatever is invested each year.
- Employer match. If you choose to invest your funds in a 401(k), 403(b) or other retirement account, you may qualify for an employer match. This is when your employer will “match” the amount you invest into the account, growing your savings faster.
- Flexibility. Once you’ve paid toward your mortgage, you can’t necessarily get the money back (unless you refinance your mortgage or take out a home equity loan). However, most investments allow you to sell and cash out your returns, giving your more flexibility accessing those funds.
- Risk. Any investment carries risk. Most investment opportunities do not have guaranteed returns, so you could end up losing instead of earning. This concern is less for those who want to be a long-term investor but is still something to consider. Knowing your investing approach, such as if you will be more aggressive or more conservative, can help you determine if it is better to invest or pay off your mortgage.
- Paying interest. If you are not paying off your mortgage faster, you will be paying interest for a longer period. Over the life of the loan, this could be tens of thousands of dollars more. That is why it’s important to balance interest savings with how much you could earn from investing.
- Equity. If you do not put more toward the principal balance on your mortgage, it will take longer to build equity, increasing the time it takes to have better qualifications for lower rates, doing a cash-out refinance, or even upgrading to a new home.
Should you pay off your mortgage early?
Paying off your mortgage early has a number of advantages, but there are also some disadvantages (as outlined above). It also truly depends on your personal situation.
For example, it is important to think about all of your debt, including auto loans, student loans, credit card bills or other types of debt you may have. Interest rates for these debts may be significantly higher than your mortgage, in which case it would be better to pay those off first.
Also keep in mind the several types of debt in general. “Good debt,” such as mortgages and student loans, offer you a favorable return on your investment, either financially or quality of life. On the other hand, “bad debt” like credit card debt, personal loans and auto loans, have no real return and can hurt your credit score faster. Paying off bad debt should be prioritized.
Another consideration is how close you are to retirement. If you are nearing retirement or already retired, you may be more motivated to pay off your mortgage early since you are no longer earning employment income. Or credit card debt, you may want to just have more cash each month, which paying off your mortgage will allow.
Before paying off your mortgage early, you should prioritize establishing an emergency fund, which should be at least 3-6 months of expenses saved in an account you only access in an emergency. While it is tempting to get all your debts paid off, not having the liquid assets or cash available in an emergency may cause you to go further into debt.
Questions to help decide if you should pay off your mortgage or invest
To summarize a lot of the information above, here are a few questions you should ask yourself to help decide if you should pay off your mortgage or invest.
- What is your mortgage interest rate? If higher, prioritize your mortgage.
- Are you retired or close to retirement? If so, prioritize your mortgage.
- What is your comfort with risk? Are you a more aggressive investor, or more conservative? If aggressive, prioritize investing. If not, prioritize your mortgage.
- Are you nearing the end of your mortgage payments? If so, prioritize investing.
- Do you have an emergency fund? If not, prioritize investing.
- Do you have other debts that should be paid off first? If so, prioritize investing.
- Do you need more flexibility with cash? If so, prioritize investing.
- Are you wanting to build more equity and lower your debt-to-income ratio? If so, prioritize your mortgage.
- How do you feel about debt? If being debt-free is important, prioritize your mortgage.
- Are you planning to move soon? If so, prioritize investing.
After reviewing these questions, you may find that you are split down the middle. In this case, do your research and use online calculators to help you estimate savings or earnings for your circumstances. You may find that doing a little bit of both is a good compromise, and that is ok too.
Is it better to pay off your mortgage or save money?
Before prioritizing paying off debt, you need to make sure you have an emergency fund. This is a cash reserve specifically set aside for unplanned expenses or financial emergencies, such as medical bills, home or auto repairs, or loss of income. Experts recommend you have at least three to six month’s worth of expenses saved, though you may want more.
Is paying off your mortgage a big deal?
Paying off your mortgage can be a big deal for several reasons. First, it eliminates that debt and frees up funds to put toward other things. You’ll also be saving money in interest, building equity, and once it is completely paid off, you will officially own your home.