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

By in Debt, Investing, Reader Question, Real Estate | 24 comments

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.

Pay off mortgage or invest in the stock market-how to decide.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.

Bonus: 10 Steps to Take Before Investing

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
2009 25.94%
2010 14.82%
2011 02.10%
2012 15.89%
2013 32.15%
2014 32.15%
2015 01.38%
2016 11.74%

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.

Read: 5 Inspiring Warren Buffett Investing Quotes

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. 

Don’t miss: 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?

A version of this article was previously published.

    24 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. 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

  15. 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

  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

  20. Yep, I was going to echo what Chuck said. Seems like a good balance could be maxing 401/403 and Roth/Traditional IRAs each year and then if the person still has extra cash left over to invest, start paying extra on the mortgage next! I think the key is if you’re keeping the mortgage, actually invest that extra money for the additional stock market gains instead of just parking it in a savings account!

    Ross

    May 21, 2017

  21. Ross, Thanks for echoing that fact. It’s easy to just leave money in cash and avoid the opportunity to pay off the mortgage. It’s certain that your mortgage interest rate is higher than the interest paid on your savings account.

    Barbara Friedberg

    May 22, 2017

  22. I would prefer having my house paid off. I know I might make more on the stock market but that feeling of having a paid off house is very liberating.

    Great post, thanks for sharing.

    Shobir

    October 24, 2017

  23. You can’t put a price on the financial freedom of living in a paid off house! Sometimes it’s about more than money!

    Barbara Friedberg

    October 24, 2017

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