Should you pay down your mortgage or invest extra cash instead?

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Got a mortgage? Got savings? Got zero other debts?

Then you’re facing a vexing age-old dilemma: Should you invest any additional savings, or should you use this money to repay your mortgage?

Let’s assume that you’re debt-free except for your mortgage. You have an emergency fund that’s tucked away safely. You’re making retirement contributions and, if applicable, also saving money in your children’s college savings accounts.

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On top of this, you’re able to save a little extra money, as well – even if it’s as small as $50 or $100 per month. And you’re not sure how you should handle these funds.

Should you invest this money? Or should you use this to accelerate the repayment on your mortgage?

Let’s explore the arguments for repaying your mortgage vs. investing.

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The case for repaying your mortgage

#1: Less money consumed by interest

Making extra payments on your mortgage holds a guaranteed payoff: You’re certain to save money on interest payments. Depending on how aggressively you repay your mortgage, your savings could total thousands, if not tens of thousands.

Let’s assume you borrow $200,000 on your home at a 5% interest rate with a 30-year fixed-rate mortgage. Your principal and interest payments come to $1,073.64 per month (excluding escrow).

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Now let’s assume that you add an extra $100 to the monthly payment, applied to principal, starting from the first payment. This simple measure, by itself, results in the mortgage getting repaid more than five years early (in 24.8 years rather than 30 years) and saves $37,069 of interest payments over the life of the loan. (*Source: Financial Mentor Calculators)

That’s a pretty compelling case for using your money to accelerate your mortgage payments.

#2: Increased cash flow

The faster you finish repaying your mortgage, the sooner you’ll have access to additional money that you can use for future investments.

In the example above, you’d finish making mortgage payments more than five years ahead of time. During those final five years, you can ‘make a payment to yourself’ every month — and invest this money instead. You’ll be able to gain exposure to the market without the additional risk that comes from having a large debt on your personal balance sheet.

#3: Forced savings

People aren’t perfect. It’s easy to debate the relative merits of investing vs. repaying the mortgage, but what’s the likelihood that you’d actually invest that money?

If you might spend those funds on a vacation in Hawaii instead, then it might be worthwhile to set up monthly automatic additional payments on your mortgage.

#4: Would you borrow to invest?

Here’s a mental exercise that might prove enlightening: Let’s imagine that you have significant equity in your home. Would you borrow against that equity, and use that money to invest?

If the answer is ‘no,’ then rationally, you also shouldn’t prioritize investing over repaying the mortgage. After all, each dollar you put into the market is a dollar that you’re ‘borrowing,’ via your mortgage. Every investment carries an opportunity cost.

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The case for investing

That said, there are several strong arguments for investing this money, as well.

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#1: Investment returns could be higher than interest rate

Many discount brokerages, including Vanguard and Charles Schwab, offer low-fee index funds that allow you to invest in the overall U.S. market. Rather than investing in specific companies (like Google or Nike), which can be riskier, you can invest in the overall market as a whole.

The U.S. broad market (the total stock market) historically returns 7% to 9% over a long-term annualized average.

If your mortgage carries a low fixed interest rate, such as 4%, you could theoretically get better results by investing your money and pocketing the ‘spread.’ For example, you might borrow money (via your mortgage) at 4% APY, hypothetically earn investment gains at 8%, and keep the 4% difference. Over the span of 30 years, this could total a significant amount of money.

There are two disclaimers here. One is that past performance is not an indicator of future performance; we don’t know what type of returns the market will produce moving forward. The second is that most investors are their own worst enemy; people have a tendency to panic-sell during downturns, turning paper losses into real losses. Long-term gains are contingent on sticking to a buy-and-hold strategy.

#2: Inflation is a mortgage holder’s friend

If you have a fixed-rate mortgage, and the country proceeds with normal rates of inflation, you’ll increasingly make payments in cheaper dollars over time.

Let’s say, for example, that your monthly principal and interest payments are fixed at $1,200 per month (excluding escrow for taxes and insurance). Today, that $1,200 can buy round-trip airfare from New York to London, a fancy purse, an Apple laptop, or a dozen nice restaurant dinners. However, 30 years from now, that same $1,200 will have substantially less purchasing power. It may only buy domestic airfare, for example, or two or three restaurant dinners.

By holding onto your fixed-rate mortgage during an inflationary period, you can repay the debt in cheaper dollars over time. And by investing, you can take advantage of inflation-driven gains.

What’s the best choice?

What’s the better option – investing or repaying your mortgage? There’s no ‘right’ or ‘wrong’ answer.

Personal finance is personal, so you’ll need to take a careful look at the arguments on both sides and make the decision that’s most comfortable for you.

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For more money-saving advice, see our Money section.

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