“A reader asked, “Am I better off making extra payments on my mortgage at 2.9% or investing the money in the stock market?”
You may have had a big win in the stock or crypto market, netting you some extra capital. Or your living expenses have recently dropped, improving your financial position. Naturally, you want to put that extra cash to work for you. So, you might be thinking, “Which is better, paying off your mortgage or investing.”
While many homeowners may consider paying off their mortgage a priority, could investing the money be more profitable? This article provides all the essential information you need to make the right decision.
- Should I Pay Off Mortgage or Invest in Stock Market?
- Investing in the Stock Market is Riskier Than Paying off Your Mortgage
- What Should You Do Before Paying off Your Mortgage?
- 1. Will You Feel Better If You Get Rid of Your Mortgage Than Receiving the Investment Gains?
- 2. Do You Expect Future Stock Market Returns to Surpass Your Mortgage Interest Rate?
- 3. Do You Know What Stock Market Returns Will Be in the Future?
- 4. How Will You Feel If You Invest in the Stock Market Instead of Paying Off Your Mortgage and the Markets Fall?
- 5. Do You Need the Tax Deduction?
- 6. Do You Have Any Credit Card Debt?
- Why Should I Invest in Stock First?
- Why Shouldn’t I Invest in Stock First?
- Why Should I Pay Off My Mortgage?
- Why Shouldn’t I Pay off my Mortgage?
- How Can I Pay Down My Mortgage and Invest?
- Where Does Investing for Retirement Fit In?
- Where Do Taxes Fit In?
- Pay Off My Mortgage or Invest | Wrap up
Should I Pay Off Mortgage or Invest in Stock Market?
The question of whether to pay off a house or invest is a favorite and one I’ve pondered many times. Actually, I’m adding $250 to my monthly mortgage payment to get the mortgage paid off by the time I retire.
Whether to pay off your mortgage early via extra mortgage payments isn’t an easy question.
Many financial and psychological aspects come into play when considering whether to pay off your mortgage or invest. The choice depends on your financial goals, how comfortable you are with debt, the loan’s interest rate and how close you are to retirement.
For some individuals, the freedom of owning your home outright is priceless. For those individuals, there’s great satisfaction in knowing that their homes are paid off.
My parents had the goal of paying off their mortgage early, and they met that goal. The fascinating part was that after paying off their mortgage, my dad said he shouldn’t have paid off the 4% mortgage when the average stock market returns were 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). The decision might have yielded a 5% profit by not paying off his mortgage – The 9% stock market return less the 4% mortgage cost yields a 5% net return.
Hidden in this story is the answer: whether you should pay off your mortgage early rests on what you’ll do with the money not used to pay off the mortgage.
One certainty is that if you pay off your mortgage, you’ll get a guaranteed return equal to the interest rate on your mortgage. So, if savings account returns are under 1%, the choice between paying off your mortgage early or saving in the bank would quickly favor paying off your mortgage.
When you pay off debt, you eliminate the loan payment, equal to the interest rate on the loan. That’s why it’s so important to pay off higher-interest debt!
But, if you choose to pay off your mortgage, what’s less certain are the future returns of the money invested in the stock market. You might pay off your mortgage and invest it in the stock market before a market decline.
Bonus: 10 Steps to Take Before Investing
Investing in the Stock Market is Riskier Than Paying off Your Mortgage
From a historical perspective, stock valuations are currently high. The S&P 500 index represents the 500 most influential companies in the US and is valued at a 21.97 price-to-earnings ratio. That means you are paying $21.97 for $1 of the company’s earnings. Contrast that with the average PE ratio of 16.00.
Currently, inflation is higher than expected and interest rates are rising, which might cause companies to curtail growth plans. As a result, earnings could decline and cause stock prices to fall as well. Even though the stock market is off it’s all time high, according to a popular stock market valuation metric, the price earnings ratio, the stock market is still richly valued.
Many experts suggest that we might be overdue for a stock market correction. Hartford Funds reports in “Ten Things you Should Know About Bear Markets” that the average time between bull markets is 3.6 years. According to that research, we are overdue for a stock market correction.
Investing now might lead to losses, not gains. Macro and fundamental research support this possibility, and the International Monetary Fund predicts slower economic growth worldwide and other economic problems persisting. The supply chain issues, low employment levels, and slow global economic growth could lead to lower stock market returns in the near future.
Ultimately, there are no guarantees for future stock market returns. Investing now subjects you to a higher-than-average financial risk, while paying off your mortgage is a sure win.
What Should You Do Before Paying off Your Mortgage?
Answer the questions below before paying off your mortgage. Weight the two options against one another to make a wise investment decision:
1. Will You Feel Better If You Get Rid of Your Mortgage Than Receiving the Investment Gains?
If the answer is YES, you can stop here and start paying off your mortgage. Your peace of mind is essential; if mortgage payment provides that, don’t look back!
2. Do You Expect Future Stock Market Returns to Surpass Your Mortgage Interest Rate?
Since historical stock returns are in the 10% range, keeping a low-rate mortgage and putting the extra cash into the stock market is a clear mathematical choice. The reader’s 2.9% mortgage rate is low. On average, his stock market investments will likely surpass 2.9% over the long term.
Yet, the stock market is volatile, and future returns are uncertain. If you can live with the volatile stock market returns and your mortgage rate is 4% or lower, then it’s likely that your stock market returns will exceed 4% over the long term. The scenario favors not paying off your mortgage early and investing in the stock market instead.
But consider the state of the market before jumping to the conclusion that applying your extra capital to stock market investments is always preferable to paying a higher monthly mortgage payment.
Interest rates often predict whether you will make a significant gain via stock investment. For example, rising and higher interest rates can curtail stock market gains and might lead to short term losses.
3. Do You Know What Stock Market Returns Will Be in the Future?
No one knows future stock market returns. Therefore, you need to understand your risk tolerance before investing. The recent stock market returns for 2019 – 2022 are 31.28%, 18.02%,, 28.47% and -18.01%. New investors, accustomed to a rising stock market might be surprised at the shock, when returns tumble.
If you’re worried about stock market declines, holding cash and short term bonds, can offset stock market losses.
4. How Will You Feel If You Invest in the Stock Market Instead of Paying Off Your Mortgage and the Markets Fall?
Imagine you decided to invest extra cash in the markets in 2000. For the subsequent 3 years, your hard-earned money would have lost nearly 40%. In fact, you wouldn’t recoup your original investment for several years.
If you’re in your 20s, 30s, or 40s and plan to dollar cost average into the markets over the upcoming decades, your long-term average returns will likely surpass 2.9%. But there’s no guarantee; your investment returns will be up and down during that time.
In contrast, paying off your mortgage is a sure thing. Once it’s paid off, you have no mortgage!
5. Do You Need the Tax Deduction?
If you are you able to itemize your tax deductions, the interest payments on your mortgage could be deductible on your tax return. This could save you money at tax time?
The government gives us many ways to reduce our federal income taxes (e.g., contribute to a retirement account, engage in small business deductions, apply home mortgage interest, and property taxes).
Keeping your mortgage longer might increase your total after-tax income. Consider seeking tax guidance from a professional.
6. Do You Have Any Credit Card Debt?
If you have any high-interest debt – such as credit card debt, short-term loans, student loans, or other high-interest debts – get rid of that debt before paying off a low interest rate mortgage. Compounding your wealth is difficult when you’re making high-interest debt payments.
Why Should I Invest in Stock First?
Below are 4 main reasons you should invest in stock first:
- Tax advantages: You may have a 401k, Roth, or other retirement account that you’re struggling to max out. In this , you might benefit more from increasing your contributions to these accounts rather than upping your monthly mortgage payment, especially if you have an employer match. Long-term thinking will grow your retirement savings, arguably more important than a mortgage post-retirement.
- Mortgage payment completion: Imagine that you have completed paying down your mortgage. In this case, would you take out another mortgage at your current mortgage rate to invest in the stock market? If this sounds logical to you, investing is the right choice.
- Liquidity ease: Investing in equities is liquid, whereas paying off mortgage debt is not. If you need quick access to cash and don’t have an emergency fund, stocks, funds, and most bonds are readily convertible into cash.
- More income generation: Investing allows you to use your funds to make more money in the form of dividend payments and capital appreciation which nets a return on your investment.
Why Shouldn’t I Invest in Stock First?
There are various drawbacks to investing in stock instead of paying off your mortgage, including the following:
- Instability: Historically, stocks are known to have a strong likelihood of capital appreciation. Unfortunately, they rarely do so progressively, and thus investing in the stock market is unpredictable. Add in retirement fund withdrawal rules, and you’re subject to greater uncertainty when investing in stocks over paying off your mortgage.
- Risk of a loss: Investing is risky as you can anticipate market performance in the future. Putting your money in the stock market can offer attractive gains and losses within no time. Also, the returns may be greater but not as steady as the increasing equity ownership in your home, as your mortgage is paid off.
- Time and effort demand: If you manager your own investments, the task requires more time and effort. In addition to managing your investment portfolio, you must keep up with the market conditions and trends research.
- Tax increase possibility: Most non-retirement or education account earnings are taxable. Thus, there may be an increase in your tax burden.
- Unqualified withdrawal penalties: Some investment accounts, like education and retirement accounts, charge significant early withdrawal penalties.
Why Should I Pay Off My Mortgage?
Here are 5 significant reasons you should pay off your mortgage:
- Peace of mind: The feeling of having your mortgage paid off is a huge incentive. Some might say investing in the stock market is more logical than ” wasting” capital on mortgage payments. Sadly, those people “waste” their money on financial advisors, investment newsletters, and stock analysis software. Hence, if being free of mortgage payments sounds appealing, think of the feeling you gain as a non-financial ROI or return on investment.
- Take-back availability: There are no take-backs if you invest in the stock market and lose some of your capital. On the contrary, it isn’t a permanent decision to pay off your mortgage: you can always “take back” paying off your mortgage early by taking out another mortgage. Or you can add extra payments to your principal, as you pay down your mortgage, and pause the payments when an investment opportunity arises.
- Guaranteed ROI: Extra monthly cash is one way to think of a paid-off mortgage. Therefore, removing mortgage payments from your budget is a guaranteed ROI. On the other hand, the stock market does not guarantee a ROI.
- Good credit score: Paying off mortgage early lowers your debt-to-income (DTI) ratio. Consequently, you could improve your credit score which qualifies you for better loan terms in the future.
- Predictable interest savings: Most mortgage loans have a predictable monthly payment at a fixed rate. Hence, what you save on loan interest is clear when you pay off the loan.
Why Shouldn’t I Pay off my Mortgage?
Below are the disadvantages of paying off a mortgage instead of investing:
- Liquidity problems: Early mortgage payment exposes you to potential liquidity issues. It can be challenging to access your money when the need arises. Although you get the cash from a home equity loan or home equity line of credit (HELOC), you may incur higher fees and get less liquidity than stocks.
- Tax deductions loss: Paying off your mortgage early denies you the tax deductions from the mortgage interest payments. The write-offs are helpful in lowering your taxable income and tax payments.
- Prepayment penalty: Before paying off your mortgage, be aware if your mortgage holder charges you a fee for paying off your mortgage early. The fee is based on the loan balance and can negatively affect your anticipated savings.
- Saving insufficiency: Paying off your mortgage early can come at the expense of your savings. Using your emergency funds for a mortgage payoff may leave you without a financial safety net, which is risky should your washer break, or your car needs repair.
- Opportunity cost: Missing profitable investment opportunities is a significant liability for paying off a mortgage early. You miss potential growth in the securities market.
How Can I Pay Down My Mortgage and Invest?
The easiest way to speed up your mortgage payment is by making extra monthly loan principal payments. In this way, not only do you pay off your mortgage more quickly, but you also save a good chunk of money.
Whether you make extra payments biweekly or with extra annual payments, contact your mortgage lender to inform them that the extra payments should be applied to the principal, not the interest portion of your loan.
Where Does Investing for Retirement Fit In?
Handling your retirement account and your early mortgage payment is a balancing act. Which to prioritize is a personal one. Consider:
- What is your mortgage rate, and how much of your monthly income is dedicated to paying your mortgage?
- How many years from now do you expect to retire?
- What are your plans for retirement income?
- What is your current cash reserve?
Ultimately, your financial situation determines the investment mix here. Paying down your mortgage is the safer option, but investing might move you further along in your goal of saving money for retirement.
Where Do Taxes Fit In?
You could reduce your taxable income by maxing out retirement accounts, such as 401ks and IRAs. The accounts grow tax-free, and Roth IRA funds can be withdrawn in retirement, without being taxed.
In addition, depending on your income bracket, you can receive a saver’s credit and a tax credit on a portion of your contribution to these accounts. But mortgage payments can also be tax-deductible.
Ultimately, you will want to consult your tax advisor to find out how your mortgage and retirement savings will affect your tax payments.
Pay Off My Mortgage or Invest | Wrap up
Ultimately, whether to pay off mortgage or invest depends on your financial standpoint. Look at your 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 comfort with debt and determine how you’ll feel living in a “paid off” home. Then, make an educated decision.
Although we’ve covered investing money in the stock market, you may also want to check out real estate crowdfunding sites for alternative investment ideas.
If the mortgage interest rate is lower than 9%, investing in stocks is better than paying off mortgage as they offer higher returns. However, the answer to this question is relative and mainly depends on your current financial position and comfort with debt. Historically, average stock returns have been higher than mortgage rates. This suggests that keeping a low interest rate mortgage and investing the difference in the stock market might be a better financial decision.
Both the house payoff and 401k investment are good financial plans. However, the latter is employer-sponsored and frequently includes matching payments into the account by your employer. Plus a 401k offers significant tax benefits. Typically investing in a 401k is better than paying off your home mortgage.
Yes, Dave Ramsey recommends paying off mortgage. His plan encourages homeowners to pay down their mortgages aggressively. How? Ramsey recommends converting your 30-year mortgage into a 15-year home loan at a fixed rate. The plan allows you to pay your loan in half the time and pay significantly less interest. You can do this yourself by making extra principal payments too.
Yes, it’s financially smart to pay off your mortgage. Going forward, early payment of the loan frees the money you would have spent on a mortgage for other uses. Although you may lose the tax deduction on your mortgage interest, and pay higher income taxes. Your tax preparer can help you understand the tax implications of paying off your mortgage early. but, if you believe that you can earn higher returns in the stock market than the interest rate on your mortgage, and you will use that money to invest, then investing in the market might be right for you.
Millionaires invest. They’ve learned the skill of investing in growing their money. Also, they have a diversified portfolio where they invest in a variety of stocks, bonds, funds, alternatives, private investments and real estate. The diversification can mitigate risk. Only the most risk aversive millionaires will pay off their mortgage.
“The best age to be debt-free (paying off mortgage included) is 45 years,” says Shark Tank personality Kevin O’Leary. He insists that paying all your debt is essential if you want to live a free financial life.
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Global Economic Effects of COVID-19 by Congressional Research Services accessed 1/16/2022, https://sgp.fas.org/crs/row/R46270.pdf
Can the FSCORE add value to anomaly-based portfolios? A reality check in the German stock market, by Eero J. Pätäri, Timo H. Leivo & Sheraz Ahmed, accessed 1/16/2022 https://link.springer.com/article/10.1007/s11408-021-00400-9
Ten Things you Should Know About Bear Markets by HartfordFunds, accessed 1/16/2022 https://www.hartfordfunds.com/practice-management/client-conversations/bear-markets.html?utm_source=hartfordfunds.com
Historical Returns on Stocks, Bonds, and Bills by NYU Stern College of Business – 1928-2021 accessed 3/16/2023https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
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