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?