Should I Pay Off My Mortgage or Save and Invest?
My wife and I bought our first house in 2007. Before we closed, I can recall co-workers joking about how I was about to sign my life away.
At the time, I rolled my eyes in subtle disgust, but as it turns out they’ve been correct so far.
I’ve had a mortgage for 17 years now, or to be more precise, I’ve had two mortgages.
The first one was paid when we sold our first home, but we promptly assumed another mortgage for the house we moved into, and I think we have about 22 years left on it unless we decide to pay it off.
The folks I know who own their houses outright say that the grass started to feel softer under their feet after they made their last house payment.
While I wouldn’t know personally, I have no doubt that casting off a mortgage would feel like quite the liberation.
But I also have a confession…
At one time in my life, my wife and I were actively trying to pay off our mortgage and we ended up regretting it.
Currently, we could direct more money toward paying off our mortgage, but we’ve decided not to.
The truth is the decision to pay off your mortgage early is a unique blend of personal preference, financial goals, and economic forces that are beyond your control.
Let’s talk about several circumstances you should consider if you’re trying to decide whether or not to direct extra cash toward paying off your mortgage early.
1) What’s Your Motive?
As I ramble on in this article, I’m going to provide several quantitative ideas to help you arrive at a decision that works for you, but none of it matters if you just hate carrying a mortgage.
Even if the math clearly points to holding your mortgage for years while you invest your extra cash, if you feel strongly that you should pay off your mortgage then I think you should.
The fact is there are people who hate debt that much and I’m not about to tell them that they’re wrong for it.
Could I make a case that it isn’t optimal? Probably. But the fact that it’s the best mathematical decision doesn’t mean it’s the best personal decision.
So, if the idea of being debt free brings a bigger smile to your face than maximizing the return on your extra cash, then I say pay it off. It’s your money and you earned it to serve your interests, whatever those are.
2) How Far Are You from Retirement?
Perhaps you’re okay with carrying a mortgage because you feel like you can earn more by investing than you can by paying down a mortgage at whatever interest rate you have.
I’m going to make this very case in a bit, but I’m going to do so with the caveat that you shouldn’t hold a mortgage in retirement if you can help it.
The reason is your retirement years could provide you with a very high degree of control over the taxable income you receive each year, effectively meaning you can control the amount you’ll pay in taxes each year.
Keeping your income low could also provide you with an opportunity to convert some of your retirement savings to a Roth IRA, potentially avoiding future taxes on Required Minimum Distributions.
Low income could also lead to lower Medicare premiums which would provide further savings.
However, if you have to pull thousands of dollars out of your retirement savings each year just to pay a mortgage, you’re going lose control over your taxes by that same amount.
Why not pay off your mortgage before you stop working so you can give yourself more flexibility with taxes at the same time you have less flexibility with income?
3) How’s Your Emergency Fund?
If you clear items one and two above and are still determined to pay off your mortgage, my next suggestion would be to consider your liquidity.
If you follow our Next Dollar Roadmap, you’ll see that we suggest holding three to six months of expenses in savings for emergencies.
If you don’t have this, then the answer is no. You shouldn’t pay off your mortgage if you don’t have plenty of cash for emergencies.
Some would argue that your net worth doesn’t take a hit if the value is in your home’s equity as opposed to your savings account, but those people have obviously never tried to liquidate part of their house to pay other bills.
Couldn’t you get a home equity line of credit in case of emergency?
Yes, but you’ll owe even higher interest on that loan and the bank could pull your line of credit at any time. It’s not really a great option for an emergency fund.
Furthermore, even if you have a well-stocked emergency fund, you might regret paying off your mortgage early anyway.
This happened to me when I lost my job in 2015.
We had over 6 months of expenses in savings, but we had directed thousands of dollars in the preceding months to pay down our 3.5% mortgage.
I didn’t realize how badly I’d want access to cash if I lost my job until I was in that situation.
I’m not saying three to six months of expenses isn’t enough savings, but I do think you should consider whether or not it feels like enough for you.
4) Are You Saving Enough?
Another factor to consider is whether you’re saving enough for retirement.
Because the benefits of compounding interest are only obtainable for investments over the long term, you can’t afford to wait until your mortgage is paid off to start saving.
This is true even if your mortgage has a “higher” interest rate. After all, you can always refinance when rates are lower, but you can’t recapture missed time as an investor.
I recommend saving 15% to 25% of your income for retirement (15% if you’re in your 20s, 20% in your 30s, and 25% in your 40s).
Paying off your mortgage should come after you have enough cash left over each month that you need to choose between saving and investing more or paying off the debt on your house.
5) What’s Your Interest Rate versus The Risk-Free Rate of Return?
For most of us, deciding whether or not to pay off the mortgage early is a math problem. We just want to maximize the value of the dollars we invest or use to pay off debt.
In fact, the math is relatively simple. You should focus your dollars where the interest rate is higher.
If the interest rate on your mortgage is higher than the interest rate on your investments, then you should pay off the mortgage.
If you can earn a higher interest rate through investing than the rate on your mortgage, you should invest.
Of course, who knows which one will be higher at any given moment?
Depending on where you invest your money, there will almost certainly be months where it would have been better to go one route or the other but there’s no way to know which one and when.
Nevertheless, there are a few things we can consider to help direct us to a final decision.
First, if the money you would commit to paying off the mortgage will be invested in stocks over a period of 5 or more years, I would invest the money.
An extended timeline like this gives your money time to recover if you happen to invest it at a bad time. Over a period of five or more years, it’s highly unlikely that you will come out worse off if you invest the money in stocks, especially if those investments are made on a monthly basis.
If you’re investing horizon is less than five years, I would compare my mortgage rate to the rate of US Treasuries for a similar period of time.
US Treasuries are the closest thing you’ll find to a “risk-free” investment. If your mortgage is lower than this rate, then there’s not a mathematical reason I can give you to pay it off early.
(Technically, the risk-free rate is a 10-year treasury minus the rate of inflation.)
Instead, you can invest that money in a virtually risk-free investment and earn more. It would be difficult to lose in this circumstance and that’s exactly the place many of us find ourselves today.
For years, interest rates in the United States were exceptionally low. Millions of mortgages were issued in the late 2010s with rates below 3.5%.
As I’m writing this in the summer of 2024, most treasury yields are still over 4% (though the two to ten-year window has dipped below 4%).
On the other hand, if you have a newer mortgage and your interest rate is in the 6-plus percent range, and you’re 40 or older, then you might want to consider paying it off or saving up to refinance.
If you’re in your 20s or 30s with a high interest rate, I’d stay focused on investing, though I’d also set a little extra cash aside to refinance when things drop back in the 5% range.
Wrap Up
If you’ve taken nothing else away from this, I hope you at least see that this decision really is up to you.
Sure, the math is helpful, but at the end of the day, it’s going to come down to your goals and the unique aspects of your mortgage.
