Should you pay off your mortgage or invest the money?

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Paying extra toward your mortgage can save thousands in interest, but investing instead might get you a better rate of return. (iStock)

If you feel weighed down by your mortgage, you might be anxious to pay it off as soon as possible. So when you find yourself with a little extra money in your budget, you may consider putting it toward your mortgage. 

Paying extra on your mortgage is always a good idea but it might not always be the best course of action. Sometimes, depending on your financial situation, you may be better off investing any extra money you have rather than sending it to your lender. You’ll want to take a close look at the numbers before making your decision. 

Here’s what you need to know about paying off your mortgage early or investing.

Crunching the numbers

Whether you should put extra money toward paying off your mortgage or investing mainly comes down to interest rates. If you can earn a higher annual return on an investment than you’re paying on your mortgage, it might make sense to invest instead. You have to do the math.

Say you have a 30-year mortgage of $250,000 with a fixed interest rate of 4%. Your monthly payment is $1,194, not including taxes and insurance. You’re paying $179,674 in interest over the life of your loan, according to Credible’s mortgage payment calculator.

After five years, your loan balance will be about $225,000. If you can start paying $170 extra each month, you’ll end up paying off your mortgage almost five years early. The amount of interest drops significantly, as well: You’ll save nearly $28,000 in interest. 

But if you take that same $170 and invest it in the stock market instead at an 8% average return, you’ll have more than $100,000 at the end of 20 years. That’s the same amount of time you’d be paying on your mortgage in this example. Consider what each of these options would mean for you.

Refinancing your mortgage can help you get a lower interest rate. With Credible, you can compare mortgage refinance rates from different lenders in minutes.

The difference between investing in your retirement vs. the stock market

Investing directly in the stock market isn’t your only option. You might also choose to put extra money into your retirement account — a 401(k) or a Roth IRA, for example.

Retirement accounts have numerous benefits when compared to a more traditional stock market investment. Both a 401(k) and Roth IRA have tax advantages. With a 401(k), you can set aside money from your paycheck before taxes, and you won’t pay taxes on the investment or its gains until you take the money out. With a Roth IRA, you invest money after taxes, but you won’t pay taxes on the money you take out in retirement. 

Keep in mind that both types of retirement accounts have limits on the amount of money you can contribute each year.

The decision is up to you, and there’s no one right answer. If your goal is to save more money for retirement, putting money in a retirement account may be better. If your goal is to have extra money available more quickly, a stock market investment may be preferable. If you’ve already reached your contribution limits on your retirement account, then a stock market investment is likely the way to go.

Advantages of paying off your mortgage early 

As you consider paying off your mortgage early or investing, be sure to weigh the pros and cons. Here are some benefits to putting extra money toward paying off your mortgage early.

  • Save money in interest — Extra mortgage payments can shave years off your mortgage and tens of thousands of dollars in interest paid over the life of the loan.
  • Get rid of debt that’s hanging over you — If you don’t pay your mortgage, you risk losing your home to foreclosure. Paying off your mortgage removes this risk and can increase your peace of mind.
  • Build equity faster — Equity is the difference between what you owe on your mortgage and what the home is worth. Extra payments go straight to the principal of the loan, meaning your equity increases faster. Homeowners can also borrow against this equity later on through a home equity loan or home equity line of credit (HELOC) if needed.
  • Improve liquidity/savings —  The money you would have paid for a monthly mortgage payment can go to other uses. You can use it to further build your emergency fund, boost your savings or fund a 529 for your children.
  • Invest more —  Since you won’t have a monthly mortgage payment, you can use that money to increase and diversify your investments.

If you decide to refinance your mortgage, check out Credible to easily compare mortgage refinance rates from various lenders.

Disadvantages of paying off your mortgage early

There are some disadvantages to paying off your home early as well. Take the following drawbacks into account.

  • Less money in your budget — If you’re paying more toward your mortgage, you’ll have less for other things, like building an emergency fund, retirement savings or unexpected expenses.
  • Can’t easily access your money — Once the money has gone to the lender, there’s no way to get it back. You won’t be able to access the equity in your home without taking out a new loan.
  • Won’t help if you run into trouble paying your mortgage — Paying extra toward your mortgage won’t count in your favor if you have trouble making a mortgage payment later on. If you’ve saved the money instead, you’ll have a reserve to help you through lean times. If you pay extra toward your mortgage, there are no credits.
  • No tax breaks — Paying off your mortgage early saves you money in interest, but you lose the benefit of the mortgage interest tax deduction. You also miss out on the tax-advantaged savings of a retirement account if you put your money toward your mortgage instead.
  • Prepayment penalties — Your lender may charge prepayment penalties for satisfying your mortgage early. These don’t usually apply to making small extra principal payments, but be sure to check with your lender.

Advantages of investing the extra money

Choosing to invest extra cash has advantages. Here are some reasons to consider investing the extra money.

  • Better returns — The stock market’s average return has historically been over 9%, according to investment bank Goldman Sachs. This is a much higher return than the rate you likely pay on your mortgage.
  • Easier access to money — With a stock market investment, you can generally sell your shares easily and have access to cash quickly. But be aware your gains will likely be subject to federal capital gains tax.
  • Employer matches — If you’re investing in a retirement account, your employer may have a matching program for your 401(k). Your employer may put in a certain percentage of your paycheck each month, or match the percentage that you contribute. This is a great way to get some free money!

Disadvantages of investing the extra money

There are drawbacks to investing the money rather than putting it toward your mortgage.

  • Mortgage debt lasts longer — Without putting your money toward your mortgage, you’ll be paying the full term of your loan — keeping you in debt longer and adding to your financial burden.
  • More risk — While stock market returns are typically higher in the long run, there’s still a substantial amount of risk. Your money is tied to the market, and markets can be volatile. You could even lose money.
  • Less pride in ownership — Stocks are an intangible asset, and you may feel less pride in ownership with a larger stock holding than you would by owning your home free and clear.

How to decide if you should pay off your mortgage or invest

Your decision on this matter will come down to your individual circumstances and your financial goals. This includes both the numbers and your own priorities. Here are some things to take into account.

  • Rate of return — Compare mortgage rates to the historical rate of return on the investment you’re considering. Will you get a higher rate of return when investing? Which will give you better long-term results?
  • Your feelings about debt — If you have the goal of being debt-free, this can be a significant factor in your decision.
  • Your risk tolerance — Will having more money tied up in the stock market add to your stress? Can you ride out dips in the market?
  • When you want to retire — If you’re heavily focused on retirement, the best option for you may be to max out your 401(k) or other retirement account(s). Consider talking to a financial adviser to figure out the best strategy for you.
  • How long you want to stay in your home — If you’re planning to move soon, tying up extra money in your home loan might not pay off.

Consider doing a little bit of both

Paying extra toward your mortgage versus investing doesn’t have to be an either-or decision. A good compromise might be to do both at once. 

If you have a significant amount of extra money in your budget, you may choose to make a smaller extra principal payment and also put more money into a retirement account or other investment. 

If your budget doesn’t have extra room now, you might consider refinancing your mortgage to a lower interest rate. If interest rates have fallen since you initially took out your mortgage, or if your financial situation has improved, you may qualify for a significantly lower rate on your mortgage. A lower mortgage interest rate translates to less interest paid over the life of the loan.

Even if you now have a lower monthly mortgage payment, you can still budget that same amount — just shift where the money goes. The money you save on your monthly payment can now go toward principal or an investment portfolio. Keep in mind, though, that if you refinance to a shorter loan term, your monthly payment will be higher and you may have less for an extra payment or an investment.

Before refinancing your mortgage, check your credit report and credit score. You can request a free copy of your credit report from each of the three credit-reporting agencies — Equifax, Experian and TransUnion — each year using a site like Lenders look at your credit score to gauge the risk of giving you a loan. Lower credit scores indicate a higher risk, and lenders will typically give you a higher interest rate. A higher credit score will mean you qualify for better interest rates. 

Compare mortgage refinance rates from different lenders in minutes using Credible.