This is an age-old question. Does it make more financial sense to pay off your mortgage quicker by increasing or adding payments, or to use that extra money and invest in an index fund in the stock market? The simple answer is to choose the option that leaves you with the most money down the road, and with low mortgage rates, the better choice is investing for the long term.
But that’s a simple answer to a complex question. There is a psychological aspect of money that differs for each person. Money isn’t all about math for most individuals. Some are good at separating emotion from money and treating their finances as a business with little emotional attachment, but that’s not common in my experience. For some people, eliminating debt is preferred over maximizing money. For one, less or no debt can reduce stress, which improves your health.
Nevertheless, Ben Stein agrees with my opinion on the matter:
Generally speaking, if you have a very low mortgage rate, it is better to invest the money than to pay off your mortgage. It’s an interesting fact — the rate of return on your mortgage is the interest you’re paying on it. If you have a 6 percent mortgage and you’re paying it off, you’re earning 6 percent. If you can earn more than 6 percent in the stock market, you should probably put it in the stock market. But, on the other hand, pay it off in an expeditious way. It’s good to have it paid off, or at least mostly paid off, by retirement time.
This simplified answer doesn’t take into account the emotional side of money. Perhaps it shouldn’t, because facts are facts (unless they’re statistics). But it also doesn’t mention tax benefits of a mortgage for those who itemize their deductions (the home mortgage interest tax deduction) and it doesn’t take into account variations in stock market returns depending on your chosen investments and on market cycles.
His last point is the important one, I think. Once you retire and income presumably drops, you don’t want to have that much of a mortgage payment preventing you from using your money for other living or enjoyment expenses.
Updated January 12, 2012 and originally published June 18, 2007. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.
Rank: Platinum
{ 45 comments… read them below or add one }
Emma: Emotions and character certainlay play a role, which is why people *feel* better about making certain decisions, despite the level of mathematical validity of those decisions for a particular individual.
I wouldn’t expect most people to want to separate their emotions from their handling of money, but I would expect that people try to understand the full consequences of their decisions. If they’re willing to forgo a low-risk future income of (for example) a few thousand dollars a year in order to feel “at ease” earlier by paying off a mortgage sooner, then that’s a perfect, *personal* decision.
This personal aspect is also why one-size-fits-all financial mantras are often bad financial advice.
I completely agree. It would be wonderful to have no mortgage when living off a fixed income. I hope I’ll be in that position. :-)
I’d sooner pay off the mortgage. Investing may pay off more, but only if I choose the right stocks, or the right funds, and the historical returns accurately predict future returns. When I pay more to the mortgage, I guarantee my interest savings. Plus I get to invest my whole mortgage payment plus my prepayment amount after it ends early. Plus I don’t have to worry about that money and how its doing, once I pay it, I’m done.
“This simplified answer doesn’t take into account the emotional side of money. Perhaps it shouldn’t, because facts are facts (unless they’re statistics).”
If this was true, then why is called ‘personal’ finance? People’s emotions and character work hand-in-hand with money, at least how money is handled.
“Once you retire and income presumably drops, you don’t want to have that much of a mortgage payment preventing you from using your money for other living or enjoyment expenses.”
Wouldn’t it be nice to have NO mortgage when you have a fixed income? :)
I think people make this decision a little haphazzardly. If you compound interest of 10% vs. 6% for 30 years, it’s overwhelmingly in favor to stock market. It’s a factor or more than a million dollars in most cases, I believe.
When I think about what’s less stressful, being debt-free or losing a million dollars, the later always comes out on top.
I think the decision has to be taken in context with your oother investments. If you have a 6% mortgage and have all your other savings in stocks, you can count money paid toward that as a lower risk portion of your portfolio. In a sense, it is diversification.
I definately agree with the last statement. You don’t want to be making payments on your home (or car or anything) at retirement.
broknowrchlatr,
I love the way you put that. Paying on a mortgage is a low-risk, low-yield investment, and in that sense it is very much a diversification of your portfolio.
Continuing with that reasoning, think about a 30-year mortgage as a 30-year fixed-rate CD. If you have a long time until retirement, how much $$ do you want to allocate to that CD vs. stocks and stock funds? The answer to that is easy . . . not much. And that’s exactly how you should think about extra payments on a mortgage: low-yield investing. Over the long-term, such investments never (at least not yet) do better than the stock market, and it’s not even close. My minimum monthly mortgage payment is enough exposure to this investment for me, since I’m just 27. I can tolerate short-term volatility to get the long-term payoff.
So am I looking at this the wrong way?
If I have a $160k 30yr fixed at 6% my payments are $989 a month. I pay $500 extra a month to pay it off early instead of investing, I pay it off in 13 years shaving 17 years off the loan and $115,038 in interest. I invest the monthly payment of 989+500 a month for 17 years and I end up with $796,898 minus a few thousand a year for taxes since I lose my mortgage interest deduction, say a good $50k over 17 years leaving me with $746,898 invested after 30 years.
OR I just put in $500 a month and end up with $1,085,600. All assuming 10% return. A difference of $338k.
I haven’t verified your numbers, Chris, but the outcome looks right . . . 338k in favor of NOT paying down the mortgage. The 4% difference between your mortgage and your stock returns gave you a big edge over the time period.
With a low interest rate on the mortgage and a high return on your investments, it’s a no-brainer as far as wealth building. Keep the mortgage and divert your free cash to investing . . . unless your investment horizon is short, like less than 10 years. In that case the low risk of the 6% mortgage may be preferable to the stock market, since in a short period your investment in the market stands a better chance of losing money.
Was anyone arguing that this wasn’t the case? It’s pretty simple math.
The only place where disagreement can arise is the psychological side of it. For most people 90% of personal finance is the psychological side. I mean, really…most of this stuff is very basic math.
For most people being completely debt free is quite the invigorating thing that allows you freedom to do what you want, when you want.
It seems all agree that investing beats accelerating a mortgage. However, I think most, (if not all) these comments presuppose that one has a lifetime to let the numbers play out. I have 10-15 years left before retirement, 29 years left on a 30 year 157,000 mortgage, and $30,000 in 403b. For me, accelerating the mortgage makes the house payment much more efficient (putting more back in my pocket) and has the potential of giving me a $200,000 house (appreciation) paid in full before retirement with a small retirement nest egg. Cash the house out and,coupled with my matured 403b, I have $250,000 for retirement. I can’t achieve that with 403b in the next 15 years. Please show me where I am mistaken. I appreciate the advice.
If I lived in the states, because of the tax deductibility of the mortgage, I would definitely put the savings to work in the stock market.
If you’re capable of earning more than 2% more than your mortgage then you should not pay it off.
If you don’t know anything about investing, you’re probably better off paying it down (after you’ve built up a large emergency fund).
I’ve seen this argued over and over. This is the first time I’ve ever commented, but it’s exasperating to see the same comments presented.
By the numbers, paying off the mortgage early or investing is basically a wash. It becomes an emotional decision.
It comes down to three factors:
1. Estimated alternative return. Long-term future return from the stock market is likely to be about 7% (not the 10% commonly quoted). See this article:
http://www.investorsfriend.com/return_versus_gdp.htm
for details. This article is the best explanation around and justifies the 7% annual return number. Don’t just quote 10%!
At 7% the difference between, for example, $1500 invested monthly for 17 years vs. 500 invested monthly for 30 years is pretty much a wash.
2. Volatility. The 7% stock market return is an average. Look at stock market cycles. If you had to cash out for retirement in 1999, for example, it would have been great. If you had to cash out in 2001, it would have been terrible. If you invest all the money in the stock market (no diversification, which would likely reduce the 7% return) then you better be comfortable with risk.
3. Taxes. The mortgage deduction tax only lasts for the first few years of the mortgage payback, and is further impacted by the AMT. There is a difference, but it’s not a huge difference.
Realistic Numbers show this decision is about emotion. The numbers are a wash. If you less oriented toward risk, then you pay off the house and diversify the investments after that. If you are more oriented toward risk, then you stay on the regular mortgage schedule, don’t diversify, and hope you sell out at a high point in the market cycle.
Your choice.
Scott main thing about retirement and mortgage is if you aren’t maxing out all retirement accounts before paying off the mortgage you are losing out on valuable time to compound money without paying taxes. Or in the Roth IRA no taxes at all.
Livingalmost,
I can agree with your statement. I get 50% employer match for me 403b contributions, up to 5% of my annual salary. Not great, but $5000 + matching $2500 is the best money available to me right now. I plan on maxing that every year. After that, it seems to me early mortgage retirement is my next best investment, since saving money is not taxable today or ever, but earning money and investing is taxable someday. Make sense? Kind of like diversifying.
I just crunched the numbers between paying off my student loan at 9.10% or saving in an online bank account at 5% the results were suprising. Because of compoundin the total of 1000 saved at 5% for twenty years would be 2,712.64 but paying off my loan early (one payment)would save me 1,174.80 in interst. Of course I still have to caluclate the taxes i would pay on my earned interest but the diffrence is 537.84 greater if I save at the lower rate and i get an interest deduction on the loan so is this emotional or not
Investing might make sense when you look at potential gains. But would you consider taking out a loan (assume reasonable interest) just to put money in the stock market. I don’t think many people would advocate that – even if it was long term. So why do that here.
I also feel better paying off loans. That is why I pay more to my super low interest student loans. Sometimes emotions override pure logic.
I read the other comments very quickly, so forgive me if I’m missing someone’s comment. But so far as I saw, I’m really amazed no one has made this very obvious point:
following up on the point made by Stein that paying off a 6% mortgage is equivalent to a 6% return on your investment– and it’s guaranteed– we should also take into account that it’s like earning 6% absolutely tax-free. Because if you’re getting rid of a debt that’s at 6% it’s arithmetically the same thing as earning a 6% return– but crucially it doesn’t involve any income as defined by the IRS!
Now I’ll admit that when I had a house I didn’t overpay my mortgage– I put extra money into the stock market instead (buy and hold, baby!). But I did this in full awareness of the fact that if I could earn 6% in stocks (outside my retirement account), I’d have to pay taxes when I sold, but if I made my debt go down and thus avoided a 6% interest rate on the same money, there would be no taxes. (Seriously: where’s the line on your 1040 to list “how much less I owe on my mortgage now”? If you can’t list it even if you wanted to, then you can’t pay taxes on this “earning”).
How ’bout just paying your mortgage bi-monthly, once on the 15th and the other at the end(assuming no prepayment penalty) You’d knock down the principle quicker thereby save tons on interest. A 30 year mortgage can be reduced to 22 years with this method. There’s no extra cost involved so the ‘extra’ you would have paid to the mortgage, you can put towards retirement investments.
A bi-monthly mortgage is really the same thing as making 1 extra payment per year. Really you are just arguing to pay down the mortgage instead of investing if you are encouraging bi-monthly payments..
Its November 2008. GM stock has been rated as $0.. worthless. Mutual funds and stock markets are down over 50%. With no end in site! I sold 80 % of my mutual funds in March of 2007 and payed my house off in Texas. I’m glad I did! Texas wasn’t in the bubble and the house is worth more today than when I bought it. If I would have left the money in mutual funds, it would have been worth $300,000 less today. Instead I have great house on the lake in Austin worth more today. I also went cash in a 4% saving account and have just now started buying aggressively in the market again. I have paid all debt off. No house or car or anything. The money I’m investing now in a declining market will pay big in the coming years.
Be debt free. You have many more options in the future. Hey, if you lose your job, you probably won’t lose your house! As we can see in this market with times of huge government spending and borrowing, times are changing.
It’s funny to read the comments from the know-it-alls above about the mathematics of investing and bla-bla-bla. I dare anyone to find a portfolio that has returned 10% annually for the last 10 years! What bull! The last 5 years s&P 500 rate is a negative -2.5%! and before that we had the 2001-2002 crash.
People win the lottery, too.
I wonder what follow up comments the posters from summer 2007 above would say now that their investments have probably lost 30-50% (or more) in the past 3 months, with no bottom in sight yet. Of course, on the flip side, their home has probably lost a chunk of value as well, but the house provides shelter and has personal practical use beyond its monetary value, which can’t be said for stock. If you’re house is paid off, you can live there for the rest of your life, even if it’s value drops 90% and you get the practical use of it. If you’re retirement investments drop 90% and you still have a mortgage to pay off, say hello to foreclosure.
Is everyone still as sanguine about making a 10% return on the stock market now as they were in June 2007?
Is everyone still as sanguine about making a 10% return on the stock market now as they were in June 2007?
The stock market has always had it’s ups and downs. While I think timing the market is futile for nearly everyone, I haven’t been able to resist myself and have recently doubled my monthly investment into several funds. It’s like money is on sale now!
The most reliable way we have to make decisions about the stock market is it’s past performance, and past performance indicates that we’ll continue to average 10% or greater returns going forward, with intermittent dips. Past performance also shows us that 95% of the 5 year periods and 100% of the 10 year periods, in the history of the stock market have made money, and 100% of the 10 year periods. Which is why if you’re investing for the short term you don’t use the stock market…
Pay off your house . Dont let these financial thieves talk you into anything else. At least you’ll have a place to sleep
We owe 120,00 on our house. My wife is retiring soon and will have 125,00 to put in investing or paying off our house. We dont have alot of other savings available. Should we pay off the house. And invest the 900.00 we pay per month on our house loan. Or just keep paying our loan and invest the 120,000 somewhere. We are 60 years old.
Pay off your morgage, you are close to your retirement. Don’t take any risk at this age.
100% of the home foreclosures are on homes with a mortgage.
100% of the home foreclosures are on homes with a mortgage.
Lots of good comments.
My situation in August 2010 will be debt free minus a $135,000 first at 4% interest. And a $89,000 2nd at 4% interest.
I will have $3500 a month extra to use to invest or pay off the mortgage and 2nd.
My thoughts were to
1) After all debts are payed, I plan on saving the 6 months emergency fund.
2) After that my choice is to go after the 2nd mortgage and put $3500 a month extra on the payment.
3) After that is when I need to decide to double the payment on the house and do the Max Deferred Comp allowed.
OR
Go after the mortgage and when payed off then put the max Deffered comp up and invest the rest?
Just had a talk with a financial advisor today.
Stated to pay off the debts first.
save 8 months emergency fund.
Then go after the 2nd mortgage.
Then refinance the first with a fixed rate.
Then Max deferred comp and $6000 a year Roth.
It’s better to pay off your mortgage. By paying off your mortgage you get a guaranteed return of 6 percent on your money. With stocks you have to pay taxes which diminishes your return rate. Earning 8 percent Before Taxes is the same as earning 6 percent on your mortgage if you are in the 25 percentile tax bracket.
The stock market or the S&P 500 went down -37.22% in 2008, which will take many years to recover from. The stock market is unpredictable so paying off your mortgage is a safe bet.
Can anyone give me an advice
I am planning to refinance my house (125K) for 10 or 15years. If I do it for 15 years I will have about 300/month for investment compare to 10 years. I can invest this money in 4% guaranteed insurance cash accumulation fund and get advantage of compounded interest. My mortgage rate is also 4%. Does it makes sense ? I have 17years before retirement. Need extra money for child’s college in 10 years.
Can anyone give me advice on this?
I have a mortgage of $171,000 (28 yrs left to pay@ 4.7% interest). Should I pay it off now using $300,000 in assets from cash, IRAs and annuities or keep making monthly payments of $1,412? I am 63 and retired and my wife is 60 and will retire in two years. Our pensions and Social Security will give us a pre-taxed monthly income of $8,100 with about $6,000 in expenses per month. We did not plan to use this $300,000 for monthly living needs.
Hey Flexo, great insight – though I have to come at this from a different angle. I don’t think most people buy a home with a return in mind, but rather for the security and independence provided through home ownership. I’m certainly not arguing your logic on which option provides a better return – in truth, I think you’re far over-estimating the return on a home (for instance, most first-time buyers don’t pay enough interest to warrant itemizing, so even the tax advantage is moot). Rather, my point is that home ownership evokes more than return – there’s an emotional attachment, a personal committment, and a sense of pride and accomplishment in owning your home outright that you just don’t get from investments. If return was the primary motivator, one could make a strong argument that renting and investing is a much better deal than buying a home.
Let me make this real simple for those thinking it is better to invest in stocks rather than pay off your mortgage early:
Would you take out a SECOND mortgage at 5% interest just to take that money and invest in stocks? A THIRD? Why not a FOURTH while you’re at it?
If yes, get as much “low interest” debt as possible and gamble in the market. If no, pay off the house!
Here are my two cents, which I do not see stated in this blog.
1.) I say hammer on the mortgage until it’s 1/2 paid off. Why? You can easily knock off several months with $5000, especially just starting a 30 mortgage. After a while, the same amount doesn’t knock as many months off. So lop the top off your mortgage, then forget about it.
2.) Stay in the same house. Transaction costs are killers when buying/selling a house.
3.) Don’t marry a crazy women. This is a tough one to accomplish.
4.) Ensure your wife works and makes good cash. This is key. Remember, if she stays at home doing nothing for several years, then when you get divorced, you have to pay her for being so useless all that time.
5.) Find a partener who respects a dollar, not someone who’s spending out of control. You can figure this out on the first few encounters.
6.) Be suspect of people assuming a12% return on a investment. This past decade wasn’t nearly that amazing, not even close. But I do believe Wall Street white collar crime is a winner.
7.) Consider all costs when making a purchase. It’s always the extras that get you.
8.) Don’t trust anyone. Well, maybe your granny.
My wife doesn’t stay at home and do “nothing”. She works extremely hard as a stay-at-home mom. Personaly, I don’t think there is anything or any job more important or noble than that of a mother.
As to the question of the day. I say pay off the mortgage. No debt guaranteed financial security. The stock market might have a higher return but past performance is no guarantee of future results.
Okay, let me revise my comment from ‘doing nothing’ to ‘earning nothing’. My apologies to your wife.
However, take a common scenario, divorce after 10 years of marriage. You as a the single income earner are on the hook for a large portion of your income, for many years. Also, living expenses rise since the couple is now living apart. Additionally, the female’s skills are now outdated making it very difficult to get anything but a low paying job. So for the sake of both parties and your finances in general, have her work as soon as is reasonable. Part time, contract, whatever it takes.
Hello everyone,
I am a single 53 year old female with a 13 year old daughter still at home. My Mother passed away recently and I inherited a little over one hundred thousand dollars. My mortage payoff is 41,000.00 and I have a second that is 14,000.00. My Lutheran Brotherhood rep tells me to invest all of it and to not pay off my mortage since I only have seven more years on the loan at 5% interest. My gutt tells me that I should pay off my mortgage and my second to be totally debt free. Any thoughts would be greatly appreciated.
Thank you,
Pam
Your gut is probably on the right track. This allows you a mortgage-free life and is an excellent way to honor you mother. You are the only one with a vested interest in your money, so why listen to anyone who would lose nothing if you lost it in the market. If the almighty gave you a financial consultation what would he(or she) say? Probably pay off what you owe first above everything!! The rich man gets richer by you keeping your mortgage open and when you invest it with him- he doesn’t need anymore help than we’ve all given him. A lot of people focus on numbers which are pretty much the “smoke and mirrors” of the con that the rich are playing on all of us. Keep in mind that you owe nothing on your mortgage compared to most and you have a great opportunity that most never get…. -from a lowly barkeep
After reading all your questions and suggestions, I decides to pay off my mortgage. With debt free, you will have lots of more options to be who you want to be like job you like but pay less. More saving or investing…etc
We just bought a $287.500 1BD CoOp and put down 20% ($57.500.00) fir which I used $28,750.00 in cash savings and took a $29.000.00 401K loan. We got a 4.25% fixed mortgage rate on the $230.000.00. Are we better off making addtl mortgage payments or, investing surplus in mutual funds? I am 51 and suppose I’ll be working for 20 yrs. more to pay mortgage. Also, I have 15 years to pay for the 401K loan which scares me more if I ever lose my job. There are no penalties for paying either mortgage or 401k loan sooner.
Thanks Alfie
One thing that I rarely see mentioned in these “pay off mortgage or invest” scenarios is the relative risk involved.
Paying off a mortgage has very low risk. The equivalent risk in investing would be an FDIC insured bank account, which is going to pay very little interest in comparison.
Today (2011) you can get mortgages aroudn 4%. To get the equivalent return in investing, you would have to go to very, very long term bonds (30 years) in a company that has a lower credit rating than U.S. treasuries. This introduces interest rate risk and return of principal risk. This is higher risk than paying off your mortgage, and all it does is match the return of paying off your mortgage.
The next option is stocks. You could get a higher return than 4%, or you could lose a substantial amount of money. You must factor risk into the equation. On average, returns in stocks are 7%, not 10% commonly quoted. And you greatly increase your risk.
Here’s another way of looking at the same situation. You are nearing retirement and your house is paid off. Should you mortgage the house for full value so you can invest the money in the stock market? If you are scoffing at that idea . . . you know what you should be doing.
And to Chris, you didn’t complete the analysis. You only looked at the difference over the first 17 years. But after the mortgage is paid off, you have much more money to put towards investments. You’ll find that you will quickly catch up, and with much lower risk. Much greater peace of mind.
Regards, Everyone.
I think we will deflate then hyperinflate.
So, IF the SHTF and your house is paid off you can stay there instead of a cardboard box with a 401K or IRA that lost all it’s value.
But IF you can keep a job and they hyperinflate it would be nice to pay off the house with depreciated dollars. The dow would probably skyrocket since it is based on dollars and those will be worthless, essentually you will have the same more or less.
What I think is going to happen is the banks are going to have to reel in their investment hedges thus collapsing the economy, first one out wins.
Hold tangable assets, that is why the central banks are secretly moving towards the exits and grabing gold.