When to Pay Off Your Mortgage or Invest Extra Capital

Should you pay off your mortgage or invest extra money? Besides the return on investment difference, sometimes you want to reduce your income.

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Growing up in suburbia, my parents’ financial focus was often paying down their mortgage as fast as they could. Jenni and I have our own mortgage, should we try to pay it off as fast as we can? Is it better to pay off the mortgage or invest when you get a surprise a bonus, raise, or other lump sums? Should you pay off your mortgage as fast as you can or invest the extra money?

This article builds upon my buy vs rent and invest article which is recommended reading.

Debt Lessons From My Parents

To be clear: my parents couldn’t always make extra payments toward the mortgage. I can remember several Christmases as a kid where they struggled to present me with the childhood they thought I should have.

My parents both worked, one with a high school degree and one with a GED. My mother put herself through night school to earn an associate’s degree when I was growing up.

A decade later, she earned her CPA and commands respect as an expert in her field at the twilight of her career.

My father has earned multiple IT technical certificates and in his later years, a real estate license.

Growing up with frequent moves

Jenni and I visited the home I attribute the most to my childhood outside of Philadelphia back in 2008. We walked the neighborhood where my best friend lived, which was across the street from the blue house pictured at the open of this article.
Jenni and I visited the home I attribute the most to my childhood outside of Philadelphia back in 2008. We walked the neighborhood where my best friend lived, which was across the street from the blue house pictured at the open of this article.

Over time, once their careers were established, they had access to 401(k)s to invest in. They’ve built up a solid nest egg. Still, most of their net worth resides in their home to this day.

I remember moving around the country several times as a child, each time to a slightly nicer neighborhood. Each move meant equity was unleashed. They always rolled the equity over into the new home, maximizing their downpayment and stretching for something a bit more expensive.

But, each move meant another load of realtor fees, transfer taxes, and general transaction costs. It’s so easy to forget these hidden costs when calculating the value of real estate investments, not to mention their opportunity costs.

Most of my teenage years were spent in a townhouse. At the end of my high school experience, they moved into a standard suburban single-family home in a nicer area.

A big single-family detached house just as I went off to college.

I remember it was the first time I’d had access to broadband internet instead of a dial-up modem in my last summer “home”.

Should You Pay Off Your Mortgage or Invest?

Deciding whether you should pay off your mortgage debt or invest extra capital into the stock market will depend mostly on what your goals are.

Let’s first look at the simple goal of having the highest net worth at the end of either decision.

We’ll use my parents as an example:

  • Home purchased in 2002 for $350K
  • Paid a downpayment of $70K (20%)
  • Debt on the property was $280K
  • 30 year fixed rate mortgage, 6% avg interest (refinanced)

Paying off the mortgage with no additional payments

In the first scenario, we’ll assume they follow the standard 30-year pay off schedule. The table below illustrates the mortgage pay off summary.

Mortgage Pay Off
Original term30 Years
Annual interest rate6%
Payment (PI)$1,679
Total scheduled payments$604,348
Total interest paid$324,348

Their $350K home ends up costing them a total of $604K in additional payments beyond their initial $70K downpayment. They’d have it paid off by 2032.

Of course, there are many other costs to homeownership but they’re irrelevant for our comparison here.

Making extra payments to pay off the mortgage faster

Now let’s look at the second scenario, which is much closer to reality. They’ve made frequent additional payments over the years in order to get the debt paid off faster.

Let’s add some new assumptions for this scenario:

  • Extra payments would otherwise be invested
  • Goal is to pay off mortgage in 18 years
  • Extra monthly payment of $435

We’ll assume they followed our guide to saving money at the grocery store to free up $435 each month. Making an extra payment of $435 every month would let them reach their desired 18-year pay off goal.

This chart illustrates the stark difference in total interest paid with the extra payments strategy.
This chart illustrates the stark difference in total interest paid with the extra payments strategy. You can run your own mortgage pay off calculation with Bankrate’s Calculator.

How does this affect our pay off summary table?

Mortgage Pay Off
Original term30 Years
Annual interest rate6%
Additional principal payment$435 per month
Payment (PI)$1,679
Accelerated payment (PI)$2,114
Total scheduled payments$604,348
Total accelerated payments$460,123
Total interest paid$324,348
Savings$144,225
Mortgage shortened by11 yrs, 10 mons

That extra $435/month of payments creates a whopping $144K worth of debt interest savings in just 18 years! If you’re curious, the total value of all those $435 payments would be just $94,830! That’s nearly a 50% return on investment.

It’s certainly a great decision compared to blowing that extra $435/month on a depreciating asset like a new car loan or consumer goods.

But how does it compare to investing that $435/month in the stock market over the same 2002-2020 timeline?

Investing extra capital instead of paying off the mortgage

Let’s assume my parents would make the smart decision of investing their extra $435 monthly payment in index funds. For this scenario, we’ll assume they use a tax-advantaged account such as an IRA, HSA, or their 401(k) to make these investments.

We’ll also assume there are no transaction fees for each monthly investment since they’re investing in index funds instead of trading individual stocks.

While I’m a fan of total market index funds like VTSAX or VTI, for simplicity’s sake we’ll calculate returns with an index fund that mirrors the S&P 500.

The chart below depicts the portfolio value when simply investing $435 per month consistently over their 18 year timeline.

There's some rocky points on the investment road like the Great Recession and Pandemic but the overall growth is impressive! You can run your own S&P 500 investment calculation with the excellent DQYDJ calculator.
There’s some rocky points on the investment road like the Great Recession and Pandemic but the overall growth is impressive! You can run your own S&P 500 investment calculation with the excellent DQYDJ calculator.

The final portfolio value is $264,630. That’s a return on investment of about 280% with the same $94,830 in extra payments!

Without making any extra mortgage payments, their debt balance at this point in year 18 would be $162K. They could pay off the mortgage balance with their investment portfolio and have about $102K leftover.

Investing in an S&P 500 index fund instead of making extra payments toward their mortgage would increase their net worth by about $102K in 2020. That’d put them 10% of the way to becoming millionaires!

So What’s Better: Extra Payments or Investments?

Some people treat extra mortgage payments as a form of savings. They could access the equity later with a home equity line of credit or refinancing, for example. For others, they just want to make the decision that will earn them the best return. However, there are times when it makes sense to pay off your mortgage in ways you don’t expect.

When to invest extra payments

Most people will do better with index funds (I like VTSAX or VTI) than with paying off their mortgage. That’s simply a function of the difference between the debt interest rate and investment return rate.

The longterm CAGR of the stock market is about 9.2% with dividends reinvested. Your debt interest rate would need to exceed market returns for making extra mortgage payments to make financial sense. That’s certainly happened before, but on average, it’s unlikely.

When to pay off your mortgage

When you’re on a path to financial independence and retiring early, you’ll likely want to limit the amount of taxable income you produce each year. That’s doubly true once you’re actually in early retirement.

Why?

If you eliminate the need to make monthly mortgage payments by paying it off early, you also reduce how much income you need. Without the associated housing costs, you’ll no longer need to earn as much money.

Lowering your taxable income (as an early retiree, this likely means selling less of your investments) could lower your tax bracket.

For example, did you know that in 2020 you could earn about $100K of capital gains as a married couple and not pay any taxes on this income? Each buck above that combination of tax bracket and standard deduction will cost you 15% in taxes.

There are lots of other reasons you may want to limit your income in order to qualify for various programs or deductions:

  • ACA subsidies
  • Medicaid
  • Nutrition assistance
  • IRA or Roth IRA income limits
  • Avoiding the AMT

Eliminating a mortgage payment you need to make can give you more flexibility in reducing your income in order to make your remaining income more efficient.

Finally, when you’re on the path to FIRE, one day you might just ask yourself “how much money is enough?” Our desire for income shouldn’t be limitless.

What about my parents?

My parents’ decision to buy instead of rent and invest has proven to be quite beneficial to their personal finances. Still, that doesn’t always mean that extra debt payments beyond the minimum monthly payment are smart.

Every extra dollar put into my parents’ mortgage over their minimum payment was a poor investment, financially speaking. That doesn’t mean they haven’t gained significant value from reducing their debt load.

The emotional and mental value of cutting debt out of your life is unquantifiable.

Jenni and I carry a mortgage on our primary residence and we thoroughly enjoy our city life experience—we don’t plan to move anytime soon. Still, I don’t think we’ll be paying down the balance of our mortgage any faster than we need to.


In what situations do you think it makes more sense to pay your mortgage off early rather than investing?
Is it ever financially more prudent to do so in the low interest rate environment of today?

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By Chris

Chris began his financial independence pursuit in 2007 as he learned basic personal finance from Get Rich Slowly as an aspiring web designer and novice investor. After several missteps, he learned the secrets of financial independence and began his pursuit of freedom.

He reached financial independence in 2018 with $1.2M and two businesses. He began the process of transitioning to early retirement in 2020.

Learn more: Meet Chris.

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Enlightened capital
23 days ago

Hey Chris-Nice post here, especially your break down of all the costs associated with real estate.

The one challenge with investing is the fact that equity multiples are so high right now and interest rates are effectively at 0%, so there aren’t any great investment options in my opinion. Ultimately I think you need to expect to earn 2-3% higher than the interest rate on your debt to invest rather than getting a guaranteed rate of return by paying down your debt.

Just my two cents.

Liz
Liz
20 days ago

Great post! My take on it is if the interest rate on the debt is less than 7% then it would benefit you to continue putting that extra money in the stock market (I love VTSAX too!) based on average returns you can expect over the long run. But I also don’t discount the psychological need to eliminate all debt for some people. So really, it comes down what works best for you and what your goals are – like you said. But nonetheless, always good to consider both options!

dan
dan
12 days ago

I really like your perspectives. I especially liked your original take on comparing the $94K of additional payments to saving interest as a ROI. That’s a great point that I haven’t seen considered or brought up before, so great catch there!

But I do have some hesitations whenever people use the past 20 years as reasons to invest over pay off debt. While 2000-09 was a horrible decade 2010-19 was one of the top 4-5 best ever. So while they kind of average out two average decades of returns would look different.

Another consideration is that the mortgage payment is set today but you can use future dollars to pay it off. However, the money invested will have a lower purchasing power by the rate of inflation which makes long-term comparisons of investing vs. paying down mortgages a little sticky. It’s a hard comparison since the mortgage payment is steady and inflation is not, but just a consideration.

Honestly, this post and your last one on rent vs. buy are great. I’ll be recommending them!