Pay off the Mortgage or Invest?

Pay off the Mortgage or Invest?

Should I aggressively pay off the mortgage or invest my extra cash instead?

A home mortgage is one of the more significant monthly expenses, and whether to pay it off and free up that money for other investments is a question we often hear. 

Maximize Tax-Advantaged Savings First

Deploying excess income to pay off a mortgage should only come into play after all sources of tax-advantaged savings have been utilized. This means maximizing 401(k), funding a backdoor Roth IRA, and taking advantage of an HSA if you are eligible. 

Pay Down Debt or Invest? 

Once you’ve maximized tax-advantaged savings, you can then consider the question: should I put excess cash into an investment account or pay down my mortgage above my normal payment?

To determine what is best, you need to compare your mortgage rate to what you could potentially earn on your investments.  Let’s say you have a 4% mortgage and could earn 9% on your stock investment account. In this scenario, you would be better off investing excess cash flow while paying as agreed on your mortgage, earning you a net return of 5%.  

Of course, the more conservative your investments are, the more likely your investment return will be lower.  Historically, a 60% stock and 40% bond portfolio has averaged a 7% annual return.  Your mortgage rate could also be higher.  As the spread between the two numbers shrinks, the more likely you will be better off paying down your mortgage. So, what is the breaking point that tips the scale towards paying down your mortgage?  

We believe you should pay down your mortgage if the difference between your mortgage rate and potential investment return is less than 3%.  So, if your mortgage rate is 4% and your investment return is 6%, you should consider paying down your mortgage before funding an investment account.  We have tested many scenarios and the big reason for our conclusion has to do with taxes. The other thing to keep in mind is that paying down your mortgage is equivalent to a guaranteed rate of return.  Nothing about the stock or bond markets is guaranteed.  So, as the spread tightens, the decision shifts in favor of paying down your mortgage.  

The Decision is Sum-of-the-Parts, Not Absolute

Of course, there are always exceptions to our rule of thumb.  The analysis considers a multitude of variables based on your unique situation. 

Besides the amount of interest you pay, your income tax rate, your mix long-term to short-term capital gains tax rates, the amount of the additional annual payments you’ll make, and the length of time it will shorten your mortgage will affect the outcome. We can model a range of situations to help you visualize the potential results to make the best decision. 

Don’t Forget Peace of Mind

One more aspect to consider – if having a mortgage-free home is important to you, that should factor into your decision. Your money is meant to be in service to your goals, and you work and save and invest to make your life easier. That includes all aspects of wellness. The spreadsheet answer is not always the right one and understanding your entire situation before deciding is the best way to move forward. 

The Bottom Line

Using an annual bonus or other income to pay off a mortgage requires careful analysis. Be sure to maximize tax-advantaged savings first, and then consider the rate of interest you are paying.

If your expected portfolio rate of return is at least 3% greater than your mortgage rate, you should seriously consider investing your extra cash and not accelerating your mortgage payments. 


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The information contained herein is intended to be used for educational purposes only and is not exhaustive.  Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return.  If applicable, historical discussions and/or opinions are not predictive of future events.  The content is presented in good faith and has been drawn from sources believed to be reliable.  The content is not intended to be legal, tax or financial advice.  Please consult a legal, tax or financial professional for information specific to your individual situation.

This content not reviewed by FINRA.

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