Extra Money: Mortgage or Investments?

The topic of paying down one’s mortgage vs. investing seems to be a never ending debate with everyone having  their own opinion on which method is better.

The argument for either side of the equation usually heats up over the topic of investment return. While some argue that investing can yield a higher after tax return based on historical figures, others posit that those historical figures are likely not going to be accurate going forward and that finding a ‘guaranteed’ rate of return in the current environment as high as your mortgage rate is improbable.

While both can make good arguments, I am not going to approach the mathematical side of this subject with this article.

The truth of the matter is that everyone’s situation is different and everyone has their own personal views on risk and debt. Truth be told, I firmly believe that we can’t reasonably compare an investment portfolio with one’s personal residence. Therefore, I view this argument as much more emotional than mathematical. It is for that reason that I want to bring to light some of the emotional trigger points that evoke the polar responses often associated with the pay down debt vs. investing debates.

Let’s start with a few basic questions that may help you decide whether it is better for you to invest or to pay down your mortgage.

1.) How many years are remaining on the current amortization of your mortgage?

If you have fewer than 10 years remaining on your mortgage amortization and your rate is fixed until maturity, you may be better off taking the guaranteed return associated with retiring your mortgage early. The reasoning behind this is that, while investments in the stock market may yield a higher return on average, ten years is a relatively short period of time to invest in the stock market. This is especially  true when we consider the necessity to achieve after-tax returns greater than your mortgage interest rate.

2.) Do you have the financial discipline to invest 100% of the amount of your mortgage payment once it is paid off?

If you choose to pay off your mortgage prior to retirement, you will have some catching up to do with respect to your investing goals for retirement. While there is peace of mind involved in being ‘mortgage free’, diverting that former mortgage payment to an investing/savings account is the perfect way to beef up your retirement portfolio.  the opponents to the pay off the mortgage early plan often cite the tempation for the new found cashflow to lure you in to a lifestyle that you won’t be able to afford once your working days are through.

3.) How confident are you in your investing abilities?

While I like to think that by investing in dividend growth stocks and dividend paying ETFs, I don’t always make the perfect investment. Yes, I even lose money sometimes 🙂

According to the statistics, most of us do not have the ability to consistently out perform the stock market indexes. What’s more, none of us have the ability to move the market which puts us at a further disadvantage. So, I must agree with Five Cent Nickel on one benefit of paying off the mortgage early:

Another advantage of paying off your mortgage early is that doing so protects you from yourself. While paying the minimum on your mortgage and investing the difference might sound like a great idea, there are no guarantees that you’ll actually follow through on the second part of the equation.

4.) What is your current state of job security and liquidity?

This is where we have to take a long, hard look at our personal situations and assess those things that could derail even our best laid plans. If you are confident in your job security and are comfortable with lower liquidity as you aggressively reduce your mortgage, then mortgage reduction may be the decision that is best for you. However, if job security is a question or if you are the sole breadwinner in the household, you may be more inclined to carry a higher level of liquidity (ie. larger emergency fund).

So, what am I doing?

I took a similar approach to this question that The Financial Highway suggests. Look at both the mathematical and emotional aspects of the equation and answer honestly to the above four questions.

Well, I am somewhat confident in my investing abilities, but the emotional side of me would like to eliminate my mortgage. However, the real benefit for me in eliminating the mortgage is in the increased cashflow provided from the complete elimination of the debt.

You see, my mortgage rate is variable and currently at 2.25% 2.50%, so the idea of paying extra payments instead of investing has little merit in reducing the overall interest paid on my mortgage.

Comparatively, saving/investing until I can eliminate the debt entirely will have the effect of keeping my funds liquid as a hedge against job loss or another financial tragedy until such time as I can mitigate the risk of job loss etc. by removing the entire mortgage payment from my liabilities.

What are your thoughts on the invest vs. pay down mortgage debate?

Resources:

Mortgage Pay Down vs. Investing Calculator

6 comments

  1. My biggest concern is the time difference between investing earlier vs. larger $$ later. We’ve all seen the charts that show the 20 y.o. who invests $5k yearly for 10 years and never invests another dime, then the 40 y.o. who puts $10k in yearly and invests till they are 65 and they still don’t have as much as the 20 y.o.

    So is it better to invest now will a little bit than to invest later with more $$?

  2. Great article. This is something that will be debated back and forth until the end of time. You made a great point in mentioning that a lot of it has to do with personal circumstances. In my case I do carry a relatively high student loan balance, but the interest rate is just a tick over 3%, and the interest is fully tax deductible. I’m confident I can outpace the interest paid with returns in my investments.

  3. Hey Tyler, great insight – and appreciate that you’re coming at this from a different angle. Too often the analysts will focus on the hard returns. Like you, I don’t think most people buy a home with a return in mind, but rather for the security and independence provided through home ownership. There’s something to be said for the peace of mind in knowing that if you lose your job or fall ill that your family will maintain a roof over their head. I’m certainly not arguing the logic on which option provides a better return – in truth, I think traditional estimates on return for home ownership are far over-estimated (for instance, most first-time buyers don’t pay enough interest to warrant itemizing, so even the tax advantage is moot). Rather, my point is that home ownership evokes more than return – there’s an emotional attachment, a personal committment, and a sense of pride and accomplishment in owning your home outright that you just don’t get from investments. If return was the primary motivator, one could make a strong argument that renting and investing is a much better deal than buying a home!

  4. Mantra,
    You should relatively safely be able to get 3% in yield alone on a portfolio of high quality dividend stocks. Best of luck! It was a great day when I made my last student loan payment, though. Eliminating debt is a fantastic feeling… almost as good as seeing growing dividends being deposited in your brokerage account! 🙂

  5. Tommy,
    On a total return basis you can absolutely make an argument for renting vs. home ownership.
    In fact, I have an uncle who has never seen the value in home ownership (granted he is a bachelor, so his lifestyle definitely plays into his decision) and has rented for decades. He maintains a very strong investment portfolio and couldn’t be bothered with the “inconveniences” of home ownership as he calls them.

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