Should I Pay Off My Mortgage or Invest in the Stock Market?
Paying Off Mortgage vs. Investing – Which is Better?
A reader asked, “Am I better off making extra payments on my mortgage at 2.9% or investing the money in the stock market?”
Should I Pay Off My Mortgage or Invest in the Markets?
This question is a favorite and a one I’ve pondered many times. Actually, I’m adding $250 to my mortgage payment every month, to get the mortgage paid off by the time I reach retirement.
Whether to pay off your mortgage or not, isn’t an easy question.
There are financial and psychological aspects when considering whether to pay off your mortgage or invest, and there’s no one right answer.
For some individuals, the freedom of owning your home outright is priceless. 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 my dad said to me, maybe I shouldn’t have paid off my 4% mortgage when average stock market returns are 9%. Dad stated that if he had kept his 4% mortgage and not paid it off, he could have used the extra cash to invest in a bond paying 9% (yes, there were safe bonds paying 9% in the past) and would have yielded a 5% (9%-4%=5%) profit by not paying off his mortgage.
The financial answer to whether you should pay off your mortgage early rests with what you’ll do with the money not used to pay off the mortgage. The one thing that’s certain, if you pay off your mortgage, you’ll get a guaranteed return equal to the interest rate on your mortgage. What’s less certain is the future returns of money invested in the stock market.
The Stock Market is Richly Valued
At present, stock valuations are high. In mid-2017, we’re in year eight of a long bull market. It’s likely that future returns won’t match those of the past eight years. If you’d invested $10,000 at the beginning of 2009, by the end of 2016, your money would have grown to $23,088 for an average annual return of 11.02%. These recent S&P 500 returns are above the average 9.53% returns for the past 88 years. In fact, experts predict lower than average stock market returns going forward.
|Year||S&P 500 Return|
Data source; http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
Ultimately, there are no guarantees for future stock market returns.
Before Paying off Your Mortgage, Answer These Questions
1. 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.
2. Do you expect future stock market returns to surpass your mortgage interest rate?
Since historical stock returns are in the 9% range, it might seem like a clear mathematical choice to keep a low rate mortgage and put the extra cash into the stock market. The reader’s 2.9% mortgage rate is low. It’s likely that his stock market investments will surpass 2.9%.
Yet, as previously discussed, the stock market is volatile and future returns are uncertain. If you can live with the volatile stock market returns, if your mortgage rate is 4% or lower, then it’s likely that over the long term your stock market returns will exceed 4%. In fact, InvestmentZen.com writes that no one should pay off their mortgage early today.
3. Do you know what stock market returns will be in the future?
No one knows future stock market returns.
4. How will you feel if you 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!
5. Do you need the tax deduction?
Are you able to itemize your tax deductions? If you have a side business then it’s likely you have 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 might increase your total after tax income.
6. 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.
Should I make extra payments on my mortgage at 2.9% or invest in the stock market?
Look at your own personal situation and honestly answer the previous questions. Next, evaluate your responses and decide if you are better off paying off your mortgage. Paying off your mortgage or investing in the stock market is a personal decision. Only you can make the decision. Analyze your own comfort with debt and determine how you’ll feel living in a “paid off” home. Then 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% return in a secure bond.
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Readers, what would you do in this situation, pay off your mortgage or invest in the financial markets?
A version of this article was previously published.