Mortgage Or Invest: Where Should Your Money Go?

Paying off your mortgage or investing your money elsewhere is a common dilemma for homeowners. The answer depends on your individual circumstances, but there are several factors to consider when making your decision. These include your risk tolerance, the interest rate on your mortgage, your financial goals, and the opportunity cost of investing elsewhere.

Paying off your mortgage early can provide peace of mind and save you thousands of dollars in interest payments. On the other hand, investing your money can potentially provide higher returns, increase your future wealth, and offer better liquidity. It's important to carefully evaluate your options and consider seeking advice from a financial advisor to make the best decision for your financial situation.

Paying off your mortgage early can save you thousands in interest

Paying off your mortgage early can save you a lot of money in interest over time. However, it's important to weigh the benefits and drawbacks before making a decision. Here are some key points to consider:

Benefits of paying off your mortgage early

• Interest savings: This is one of the most significant advantages of paying off your loan early. You could save thousands or even tens of thousands of dollars in interest payments. Paying off your mortgage early guarantees a return on your investment.
• Peace of mind: If you're uncomfortable with the idea of being in constant debt, paying off your mortgage early can ease your burden. Owning your home outright can provide a sense of financial security and reduce stress.
• Build equity: Paying down your mortgage faster increases the equity in your home, which can be beneficial if you want to refinance or take out a home equity loan or line of credit.

Drawbacks of paying off your mortgage early

• Opportunity cost: Any extra money you put towards paying off your mortgage early is money that could be invested in other financial goals, such as retirement savings or emergency funds.
• Wealth is tied up: Your property is an illiquid asset, meaning it can't be quickly or easily converted into cash. If you need money in an emergency or want to seize an investment opportunity, you would need to sell your house, which can be a time-consuming process.
• Loss of tax benefits: In some countries, paying off your mortgage early may result in losing tax deductions for mortgage interest if you normally itemize your deductions. Consult a financial advisor or tax specialist for guidance on tax implications.

Factors to consider

When deciding whether to pay off your mortgage early, consider the following:

• Interest rates: Compare the interest rate on your mortgage to potential investment returns. If your mortgage rate is higher than what you could earn by investing, paying off the mortgage early may be more advantageous.
• Risk tolerance: Paying off your mortgage is generally considered a safer and more predictable option. Investing carries the potential for higher returns but also comes with higher risk. Evaluate your risk tolerance and financial goals to determine which option aligns better with your circumstances.
• Financial situation: Assess your overall financial picture, including any other debts, emergency funds, and retirement savings. Ensure that paying off your mortgage early won't compromise your financial stability or ability to handle unexpected expenses.
• Prepayment penalties: Some mortgages may have prepayment penalties, which are fees charged by the lender if you pay off the loan early. Review the terms of your mortgage contract to understand if there are any prepayment penalties and their potential impact.

Investing instead may generate higher returns than the interest saved

Investing your money instead of paying off your mortgage early may generate higher returns than the interest saved. The stock market has the potential to provide a higher average rate of return than the average mortgage interest rate. For instance, if your mortgage rate is 3% and the average yearly return on investments is 8%, you will still be making 5% even after accounting for the interest on your mortgage.

The S&P 500 has returned an average of 10% to 11% annually since its inception in 1926 through 2018. If you decide to invest in an index fund that tracks the S&P 500, you can expect an average annual return of 8% on your investment. At the end of 19 years, which is the approximate time it would take to pay off a mortgage early, you would have around $160,780. That is more than double the interest you would save by paying off your mortgage early.

Additionally, investing in the stock market provides better liquidity than paying off your mortgage early. Stocks, bonds, and similar investments are easier to sell and access your money compared to selling your home or attempting a cash-out refinance.

However, investing in the stock market is riskier than paying off your mortgage. The stock market is volatile, and you may gain or lose thousands of dollars. Your returns may exceed the returns from paying off a mortgage, but they are not as safe and fixed.

Ultimately, the decision to invest or pay off your mortgage early depends on your financial situation and risk tolerance. Consult a financial advisor to help you assess your finances and make the best decision for you.

Paying off your mortgage can give you peace of mind

While investing is a great way to grow your wealth, paying off your mortgage can give you peace of mind. Here are some reasons why you may want to consider paying off your mortgage early:

Interest savings

Paying off your mortgage early can result in significant interest savings. By reducing the principal amount early on, you can save thousands of dollars in interest over the life of the loan.

Debt-free

Being debt-free and owning your home outright can be liberating. It can free up your cash flow, allowing you to invest in other areas or pursue personal interests.

Build equity

Paying down your mortgage faster helps build equity in your home more quickly. This can make it easier to qualify for refinancing or leverage your equity through a home equity line of credit (HELOC) or cash-out refinance for home improvements or paying off other debts.

Reduced risk

Paying off your mortgage early eliminates the risk of losing your home to foreclosure if you experience financial difficulties. It also reduces your overall debt, which can improve your financial stability and creditworthiness.

Tax benefits

In some cases, paying off your mortgage early can result in tax benefits. Mortgage interest is often tax-deductible, so eliminating this interest expense can increase your tax liability.

Emotional benefits

For some people, the emotional benefit of being debt-free outweighs the potential financial gains of investing. Paying off your mortgage can provide a sense of security, independence, and autonomy.

Investing in stocks, bonds and similar is better for liquidity

Liquidity is a key consideration when deciding whether to pay off your mortgage or invest. It refers to how easily an asset can be converted into cash without affecting its market price. Cash is the most liquid asset, while tangible items like property are less liquid.

Investing in stocks, bonds, and similar assets is generally better for liquidity. These are considered liquid assets and can be converted to cash relatively quickly and easily. The stock market is characterised by high liquidity, meaning there is a high supply and demand for stocks, so it is easy for buyers to find sellers and vice versa. Transactions can be completed swiftly, even when stock values are dropping.

On the other hand, property is an illiquid asset. It can take a long time to sell, and there may be additional costs involved, such as broker fees. If you need to access your money quickly, investing in the stock market may be a better option than paying off your mortgage, as you can avoid getting locked into an illiquid asset like property.

However, it is important to remember that investing in the stock market carries more risk than paying off your mortgage. While stocks offer higher potential returns, there is also the possibility of losing money. Paying off your mortgage early provides guaranteed savings and the security of owning your home debt-free.

Ultimately, the decision to pay off your mortgage or invest depends on your individual circumstances, risk tolerance, and financial goals. Consult a financial advisor to help you make an informed decision.

Paying off your mortgage may be better if you're nearing retirement

Peace of Mind

If you're approaching retirement, you may want to prioritise paying off your mortgage to reduce any financial stress or uncertainty. By paying off your mortgage, you can enter retirement with the peace of mind that comes with being debt-free and not having to worry about monthly mortgage payments. This can be especially beneficial if you're no longer earning a steady employment income.

Interest Savings

Paying off your mortgage early can result in significant interest savings. Since most of the early mortgage payments go towards interest, making extra payments during this period can substantially reduce the total interest paid over the life of the loan. This can save you thousands of dollars and provide a guaranteed return on your investment.

Budget Flexibility

Once your mortgage is paid off, you'll have more flexibility in your budget. The money that was previously dedicated to mortgage payments can now be allocated to other expenses or investments. This can be particularly advantageous if you're nearing retirement and want to maximise your savings or investment opportunities.

Building Equity

Paying off your mortgage faster allows you to build equity in your home more quickly. This can be beneficial if you're considering refinancing or leveraging your equity through a home equity loan or line of credit (HELOC) for renovations or other financial goals.

Tax Considerations

Mortgage interest is tax-deductible if you itemise deductions on your income tax return. However, if you pay off your mortgage early, you may lose this potential tax deduction. Therefore, retaining the mortgage and benefiting from the tax deduction may be more advantageous, depending on your individual tax situation.

Retirement Savings

While paying off your mortgage can provide financial stability, it's important to consider your retirement savings simultaneously. The earlier you start saving for retirement, the more you can benefit from compound interest. Therefore, balancing mortgage payments with retirement savings is crucial to ensure you're adequately prepared for the future.

Frequently asked questions