When my wife and I used to have mortgage loans, we paid them off as quickly as possible. We like being debt-free, and we saved thousands of dollars in interest by investing our money in paying down those loans.
But I’ve never been sure we made the right decision, which brings us to an important question:
If you have something left over after your monthly expenses, or you have occasional windfalls, is paying off your mortgage the best “investment” you can make?
Let’s look at the arguments…
Should You Keep the Debt and Invest?
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Many financial writers point out that a mortgage loan is cheap debt, so they suggest using it to make more money.
“From a purely quantitative standpoint, the economic benefit to maintaining a mortgage and investing the difference is significant for most homeowners over the past several decades,” Larry Light writes for Forbes.
The idea is simple enough: Average returns in the stock market are higher than current mortgage interest rates.
Consider an example: If you have $5,000 and use it to pay down your mortgage loan that has a 5% interest rate, you get an effective “investment return” of 5%.
The stock market has an average annual return of close to 10% (measuring the S&P 500 over the last 30 years), so it may make sense to keep the debt and invest your money in index mutual funds.
But it really isn’t that simple…
For one thing, if you have a heavy load of high-interest debt, like student or car loans and credit card balances, you may want to “invest” in paying down that debt before considering working on your mortgage loan or stock portfolio.
After all, the average interest rate on credit cards is around 15%, much higher than mortgage rates and average stock market returns.
But even if you have your student and consumer debt under control, you still might want to skip the market for now…
Or Should You Pay Off Your Mortgage Early?
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Here are some of the reasons you might want to pay off your mortgage loan instead of investing your savings and extra income.
Guaranteed Return
When you pay down your mortgage, your “savings return” on your investment is guaranteed. In other words, if you owe less you will definitely save on interest charges.
Most other investment returns are far from guaranteed.
A 100-year chart of the Dow Jones Industrial Average reveals a number of times when the stock market not only dropped rapidly, but also times when it took five years, 10 years or longer to get back to even (just look at the stretch from 1965 to 1995).
A lot can happen in a decade, and you might have to cash in those investments when they’re down by half.
Peace of Mind
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It’s tough to put a price on greater peace of mind, but it’s certainly worth something. My wife and I were finishing off our last mortgage during the stock market crash of 2008, paying thousands of extra dollars on it every month.
Had we instead invested the money in the market, we may have been looking good all these years later, but I don’t think I would have slept very well while stocks were dropping 30% or more in value.
Having no debt and a free-and-clear house also provides peace of mind. About the time we paid off our last mortgage, the headlines were full of stories of foreclosures — something we never had to worry about.
No Unexpected Investment Mistakes
If I crunched the numbers, I might find we’d actually be further ahead if we’d invested, rather than paying off our past mortgages.
But that assumes smart (or lucky) investing. Paying down a mortgage was simple, while picking the right investments is not. One study found only two out of 2,862 surveyed mutual funds consistently beat the market as a whole.
Less Temptation
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Most of us know someone who has borrowed from his or her 401(k) for a vacation or other non-necessities.
The more difficult process of borrowing from your home equity means you’re less likely to fold to these various temptations. To some extent, you lock up your savings when you use them to pay down your mortgage loan.
Lower Housing Costs
Once you’ve paid off your mortgage loan, you have permanently lower monthly housing costs. My wife and I like that.
It makes it easier to survive the loss of a job or other income, and much easier to finally start saving money for those retirement investments.
The Verdict?
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So is it better to pay down a mortgage loan or invest your excess income?
If you’re paying 4% on a mortgage loan and the stock market just crashed, it’s very likely you can do better putting your money into the market at the bottom and riding it back up.
On the other hand, the market could keep dropping, you could choose the wrong investments, you could be tempted to spend some of that money, and a time may come when you wish you didn’t have the house payment you could’ve eliminated.
For us, peace of mind tipped the scales in favor of paying off our mortgage loans, but there is no simple answer.
Your Turn: Do you think it’s better to pay off your mortgage faster or to invest your extra income instead?
Steve Gillman is the author of “101 Weird Ways to Make Money” and creator of EveryWayToMakeMoney.com. He’s been a repo-man, walking stick carver, search engine evaluator, house flipper, tram driver, process server, mock juror, and roulette croupier, but of more than 100 ways he has made money, writing is his favorite (so far).
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