Should I Pay Off My Mortgage or Invest in the Stock Market?

By in Debt, Investing, Reader Question, Real Estate | 20 comments

Your Investing Questions Answered

Welcome to the 2nd “Your Investing Questions Answered” Thursday.

Mike from Get Rich with Me asks;

“Am I better of making over payments on my mortgage at 2.9% or investing the money in the stock market?”

 Should I Pay Down My Mortgage or Invest in the Markets?

This is a personal favorite of mine and a question I’ve pondered many times.

The short answer is, it depends.

This question is a financial and psychological question.

For some individuals, the freedom of having no mortgage is very important. For those individuals, there is a great satisfaction knowing that their home is paid off. My parents had the goal of paying off their mortgage, and they met that goal. The fascinating part was, after they paid off their mortgage, we discussed a version of Mike’s question, and my dad said to me, maybe I shouldn’t have paid off my 4% mortgage when market interest rates are 9%. My dad went on to discuss  how by keeping his 4% mortgage and not paying it off, he could have used the extra cash to invest in a bond paying 9% and would have yielded a 5% (9%-4%=5%) profit.

This is an example of the trade off between paying off one’s mortgage or using the cash for investing.

Today’s situation is not so clear cut.

Today, interest rates are very low and future stock market returns are quite uncertain given the multi year bull market we recently experienced.

Consider These Questions Before Paying off Your Mortgage

Will you feel better if you get rid of your mortgage?

If the answer is yes, then you can stop right here and start paying off your mortgage.

We took out a 3.66% 15 year mortgage in 2012 with the idea that when retirement rolls around, our mortgage will be paid off. While we’re actively working, we prefer to have a mortgage  for the tax benefit.

Do you Expect Future Stock Market Returns to Surpass 2.9%?

Since historical stock returns are in the 9% range, it would seem like a clear mathematical choice to hold on to the mortgage and put the extra cash into the stock market. Using the prior example, it appears as though your expected average return would be 9% – 2.9% = 6.1%.

Wait a moment, future stock market returns are uncertain. It’s a good idea to understand the volatility of stock market returns.

Do you know what stock market returns will be in the future?

No one knows future stock market returns.

Look at this S & P 500 chart from 1995 to December, 2013:

Historical stock market returns

S & P 500- 1995-2013

How will you feel if you use the money to invest in the stock market and the markets fall?

Imagine you decided to start investing your extra cash in the markets in 2000. For the next 3 years, your hard earned money would be worth less. In fact, you wouldn’t recoup your original investment for several years.

If you’re in your 20′s, 30′s, 0r 40′s and plan to dollar cost average into the markets over the upcoming decades, then your long term average returns are likely to surpass 2.9%. But there’s no guarantee and during that time there will be ups and downs in the investment returns.

Paying off your mortgage is a sure thing. Once it is paid off, you have no mortgage!

Do you need the tax deduction?

Are you able to itemize your tax deductions? If you’re a blogger or have a side business, you probably have some schedule C income (or loss). In general, the government gives us many ways to reduce our federal income taxes (contribute to a retirement account, small business deductions, home mortgage interest and property taxes). Keeping your mortgage longer may increase your total after tax income.

Do you have any credit card debt?

Pay off high interest rate debt first.

If you have any high interest rate debt; credit card, short term loans, or student loans, get rid of those first. It’s difficult to compound your wealth when you’re paying high debt interest payments.

Am I better of making over payments on my mortgage at 2.9% or investing the money in the stock market ?

Look at your own personal situation. Honestly answer the previous questions and decide if you are better off paying off your mortgage.

Only you can make the decision for yourself. By analyzing your own comfort with debt and how you will feel living in a “paid off” home you can make an educated decision.

Although you asked about investing the money in the stock market, it’s also wise to check out bond rates and see if you can improve on the 2.9% mortgage rate in a secure bond. Hint: the answer to this question will change with changes in market interest rates.

Don’t miss Investing Questions Answered #1: SEP IRA versus Solo 401(k); Which is Better?

Readers, what would you do in this situation, pay off your mortgage or invest in the financial markets?

 

    20 Comments

  1. I have always thought of mortgages as the greatest leveraged investment! You get low interest, government subsidy (tax deduction) and the asset increases in value over time. This was true until the real estate bubble changed everything. I still think it is good, but you need to use common sense in your investing. My thinking has changed as I near (3 years) retirement. I still think I rather invest in the stock market as well as other investments that are more diverse and liquid than real estate particularly with interest rates so low.

    krantcents

    January 2, 2014

  2. The -3% guaranteed, risk-free return from prepaying a mortgage feels pretty appealing to me, especially in the context of that S&P 500 chart. Two ~50% crashes in 15 years, yikes!

    Kurt @ Money Counselor

    January 2, 2014

  3. @Krantc-My thinking is in line with yours, especially with such low interest rates. It’s a wonderful way to grow your wealth by holding a low interest rate mortgage,take the tax break and attempt to earn more than your mortgage interest rate in the investment markets.
    @Kurt-Your comments offer the contrasting view to Krantcents. And the important part about this discussion is there is no “right answer”. Your decision on the “to pay or not to pay” question is an individual one.

    Barbara Friedberg

    January 2, 2014

  4. When you are not sure, do both! That’s what I do! But excellent advice as always – there is no one-size-fits all answer!

    Moneycone

    January 3, 2014

  5. I think it might be worth considering how long you intend to stay in your home as well. If you plan to move in a few years, you might not want to tie up cash in home equity.

  6. @Moneycone-Such a simple solution. Do both, in other words, pay a bit more towards the principal of your mortgage and invest in the markets. Thanks for the solution.

    Barbara Friedberg

    January 3, 2014

  7. I don’t look at a primary home with a mortgage as an investment but an expense. However, the expense has benefits such on taxes. The goal has always been to use the money to make more of it and that would be looking at ways to increase passive income (investing).

    I get this question often when I’m traveling and I always defer them to think about their personal situation. It depends really on a persons comfort level and desire to invest their money in the market or simply want to be completely debt free.

    The Phroogal Jason

    January 4, 2014

  8. @Jason, The last statement of your comment summarizes the issue; if you want to be completely debt free, then that’s the answer for you. If that’s not a concern, then there are more financial issues to look at.

    Barbara Friedberg

    January 4, 2014

  9. I work as a Bank Manager and have clients ask this a lot. I usually ask if they’re currently maxing ira’s and 401k’s, if not… I suggest they put their extra funds there vs. accelerated Mortgage payoff, unless the rate on the mortgage is over 6 or 7%.

    Chuck@Tortoise Banker

    January 4, 2014

    • Hi Chuck, That’s the “financially” correct answer with the greater probability of growing your wealth with leverage. The problem is, many people want that psychological comfort of eliminating all debt. As usual, there’s no “one correct answer”.

      Barbara Friedberg

      January 4, 2014

  10. I would try and pay off my mortgage. I’d feel so much better by removing the burden of debt compared to the delight of investment appreciation. Once I pay the mortgage off I can completely concentrate on investing my money for retirement.

  11. Hi Nick, That’s one more vote for “pay off the mortgage”. These responses show just how personal – finance is.

    Barbara Friedberg

    January 5, 2014

  12. I would pay off my mortgage and look for other safer ways to invest such as in the bonds.

    Doraine Richards

    January 7, 2014

  13. I’ve got a 3.5% mortgage and will never pay off that sucker! I’m dollar cost averaging in a diversified portfolio of index mutual funds. I also try to rebalance quarterly to avoid overexposure in asset classes that have outperformed. I also have the cash flow that will allow me to live comfortably into retirement with a mortgage payment.

    Paul @ The Frugal Toad

    January 7, 2014

  14. Nice article, and I agree it’s not always either/or. 18% credit card or pay the mortgage? Sorry, you think that’s an easy choice? I banged my head against the wall explaining. Someone wrote that $100 to their mortgage saved them over $400 in interest over the 29 years remaining, yet the 18% was “only $18.” Yes, it took a bit of back and forth to set him straight.
    I also try explain, but not always successful, that a matched 401(k) should take priority. So long as that match is taken, then all higher interest debt paid, if one wishes, a faster paydown might let them sleep better. Still, I warn, if you lose your job the day after you’ve paid your mortgage in full, you still have a property tax bill and other obligations. Important to have a cushion.
    It may be semantics, but I don’t keep the mortgage ‘for the tax break,’ but I am sure to view it on a tax adjusted basis, e.g. my 3.5% mortgage was really costing me 2.5%, below the long term inflation rate. Kinda makes it ‘free.’

    JoeTaxpayer

    January 15, 2014

  15. Hi Joe,

    I echo your thinking about; 1) pay off the credit cards first and 2) You better have some cash on hand if you pay off the mortgage. Not only will you still need to pay the taxes, but the repairs and maintenance never stop!!

    What are you referring to here? e.g. my 3.5% mortgage was really costing me 2.5%, below the long term inflation rate. Kinda makes it ‘free.’

    Barbara Friedberg

    January 15, 2014

  16. This is good info, thanks. I like your short answer (which seems like the only responsible way to answer anything). I also like the idea to do a bit of both, although I put my money in diversified investments instead of prepaying. My mortgage is extremely manageable, and I like the idea of having flexibility.

    FF

    January 15, 2014

  17. @FF, With such low mortgage rates, I also prefer to keep my mortgage and use additional funds for investing and saving.

    Barbara Friedberg

    January 16, 2014

  18. I personally lean towards investing. Mortgage debt on your primary property is the cheapest available and so (if the risk is managed well over long periods) it should be possible to obtain a better ROI that the mortgage rate.

    That seems obvious at the moment when we are looking at 2-4% mortgage rates. When they were more like 10% in the 90s, this probably wasn’t so clear cut!

    Therefore, we need to not only think about what the markets are going to do in the future, but also what will happen to the interest rates (unless you can obtain those low rates on a 30 year fixed – which there is no chance of in the UK with current rules).

    moneystepper

    January 18, 2014

  19. @Moneystepper,
    If history is any guide, then as you stated, financial market returns are likely higher than the cost of the mortgage. You answer is quite logical, although psychological issues can change the decision. (My personal choice is in accord with your thinking)

    Barbara Friedberg

    January 19, 2014

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  1. Friday Finds 1/10 | Three Thrifty Guys - […] Should you pay off your mortgage or invest? […]
  2. » Your Mortgage Is Killing You: Why You’re Broke, #1 MakingCentz - […] some that advise investing your money rather than working to pay off the loan as soon as possible. Financial …

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