Congratulations on that big promotion! You’re financially comfortable with a nice nest egg and now you have some extra cash coming in. So, what do you do with it? Pay down your mortgage, or invest for the long term? 

The thought of getting rid of debt feels good and will pay off in the interest you save over the remaining term of the loan. But depending on your specific circumstances, investing the money will yield more—especially if you’re starting young and the returns add up for decades.

Your best bet depends on many factors: your mortgage rate, your home value and how much homes are appreciating in your neighborhood, your tax bracket, expected inflation, and your personal risk tolerance. We can run scenarios on your specific circumstances to help you make the right call.

In general, if your mortgage rate is lower than the rates you’ll earn in the market, you’re better off investing, especially if you are under 50, in a high tax bracket and comfortable with risk.

Mortgage debt may feel like a burden, but it’s not all bad. Mortgage rates are traditionally low, and because the interest is generally deductible, it reduces your taxable income. In effect, this lowers the real rate you’re paying even further.

Paying off your mortgage faster limits your liquidity; it puts your money in an asset you must sell (at significant time and effort) to use. And reducing the debt on your house doesn’t make your house worth more. It saves you money on interest, which you can spend or invest elsewhere, but it doesn’t grow your money. 

In recent years, when it was a struggle to score market returns much higher than mortgage rates, paying down the debt looked attractive. But the key is to think long-term and capture the benefits of compounding. Your invested money will grow, and you’ll earn interest on the interest. 

Of course, market returns will vary and you may experience losses. That’s precisely why investment returns are historically higher—to compensate you, the investor, for taking that risk. But in many cases, if you simply pay your mortgage as scheduled and begin investing any extra cash, compounding will net more in returns than you would have saved in interest putting the same cash against your mortgage.

Compounding works its magic on both interest owed and interest earned, so paying extra on the mortgage has the biggest impact if you do so in the early years of the loan. But be sure to start investing for retirement early to let those gains grow over years, too. 

Remember: this isn’t an either/or choice. You can invest most of your spare cash and pay down the mortgage a little. Better yet, you can refinance and invest more aggressively. Rates for a 15-year fixed rate are now just over 3%, which is well under the rate of market returns, so you can invest the interest you save plus your spare cash and watch your returns add up.

—Toni L. Shears

Sources: 

Tanza Loudenbeck, “Should you pay off your mortgage early or invest? We did the math to find out which nets a greater return,” Business Insider, Sept. 15, 2020https://www.businessinsider.com/personal-finance/pay-off-mortgage-early-or-invest-calculation-financial-planner

Jason Steele, “Spend or Save: Should I Pay off My Mortgage or Invest for Retirement?” Investopedia, Sept. 26, 2019, https://www.investopedia.com/mortgage-or-retirement-4770977.

Hal M. Bundrick, “Invest or Pay of Your Mortgage? How to Decide,” Nerdwallet, Aug. 19, 2017, https://www.nerdwallet.com/blog/mortgages/invest-or-pay-off-your-mortgage-heres-how-to-decide/