Should You Pay Down Your Mortgage or Invest the Cash?

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Should You Pay Off Your Mortgage or Invest?Touchy subject time: Should you pay down your mortgage rapidly OR invest the cash?

This question always brings out the punches, kicks and jabs. People have STRONG emotions about debt, even low-interest mortgage debt.

Through Afford Anything lens of “Stop Shouting, Start Thinking,” let’s walk through the potential consequences. You decide.

Everything Has Risk. Period.

Most people want to pay off their mortgage for three reasons:

#1: Emotion: Peace-of-mind
#2: Risk-Management: Reduce the chance of a foreclosure
#3: Savings: Lower their interest payments

These are all great reasons. But nothing is the “best” choice in a vacuum. It has to be compared to an alternative.

Alternative #1: Spend the money on champagne and strippers. Obviously a terrible choice.
Alternative #2: Invest the money. Okay, this could be a valid option. Let’s explore it.

Stocks, historically, have yielded an 8 percent long-term annualized return over the past few decades. Legendary investor Warren Buffet predicts that number will be closer to 7 percent in the coming years. For the sake of argument, let’s assume Buffet is right.

Now let’s rephase the question. Are you willing to pay extra to get rid of your mortgage faster?

That’s not a rhetorical question. Missed opportunity has its price. If you’re willing to pay the opportunity cost for the sake of reducing your risk — Great! Go for it! You might be leaving money on the table. If you’re okay with that, then you have your answer.

Notice I asked if you’re willing to pay the opportunity cost. That doesn’t mean you will. No one knows what the future holds. If the markets perform as they historically have done, you’ll miss opportunity. But if stocks tank, you’ll come out ahead.

There’s risk in every decision, even the decision to become debt-free.

Should you save or pay off debt? Or invest? Each option has pro’s and con’s.

Paying off your mortgage has:

  • Guaranteed interest savings
  • Limited upside
  • Unknown missed opportunities

Investing is:

  • Risky
  • Greater potential for upside
  • Stronger chance to capitalize on opportunity

Opportunity Cost

You have $100,000 in cash. (Congrats!) You also have a brand-new 15-year mortgage with a balance of $100,000, at 4 percent. (For simplicity sake, I’m leaving taxes out of the equation.)

Scenario A: You pay off your mortgage. You save $33,143 in interest payments. You invest $739 per month, the amount that would’ve been your mortgage payment. You contribute every month for 15 years and it grows at 7 percent. At the end of the term, your portfolio is worth $237,706. Hooray!

Scenario B: You invest the entire lump sum in the market. You make no additional contributions. In 15 years, your portfolio is worth $284,894. You’ve also paid $33,143 in mortgage interest, which you subtract out. Your net gain is $251,751. Wahoo!

Under this scenario, you’ve lost the opportunity to make $14,045 by paying down your mortgage early. Boo! That’s a strong argument for investing.

On the other hand, you’ve enjoyed peace-of-mind, which DOES have a value. You have less risk, higher liquidity and more flexibility.

Is that peace-of-mind worth $14,045? You decide.

Scenario C: You invest the money. The market tanks. You lose your job. Your house gets foreclosed on. Your spouse leaves you, your dog bites you, and even your goldfish won’t look at you anymore.

It’s a worst-case scenario, but it’s possible. Now the $14,045 looks like cheap insurance.

(What about borrowing to invest in real estate? Here’s my take.)

Quit Being Ideological

You know what’s funny about being a personal finance blogger AND a real estate investor? I hear ideologues on both sides of the aisle.

Finance bloggers, as a group, tend to have knee-jerk reactions to the word “debt.” Debt bad! Debt bad!

Real estate enthusiasts tend to have the opposite reaction. Gimme leverage! More and more and more leverage!

Half the emails I receive about this topic come from people who say, “Are you going to pay off your houses as fast as possible?” The other half ask, “Why aren’t you borrowing more?!”

Don’t make decisions based on ideology. Everything financial, even debt payoff, comes at a price. Everything carries risk. Risk wears different costumes, appears in different forms. But it’s there.

Avoid knee-jerk reactions and zombie ideology. Weigh the risks. Make a spreadsheet. Calculate missed opportunities. Imagine the worst-case scenario and ask yourself if it’s something you can live with.

Make choices based on information, not ideology.

Then decide for yourself.

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41 Responses to “Should You Pay Down Your Mortgage or Invest the Cash?”

  1. Kevin @ RewardBoost
    22. Mar, 2013 at 11:57 am #

    Well if my options are to invest in the market or pay down a mortgage, I choose neither. I’d rather invest in a small business or even in P2P lending. I don’t trust the stock market as far as I can throw it, and I’m happy to hold debt at 3.625% interest (which is where my current mortgage sits).

    • Afford Anything
      22. Mar, 2013 at 12:28 pm #

      @Kevin — Funding your own business and P2P lending are both great options. I’d like to experiment (in “small bets,” maybe starting with $500) with P2P lending in the future.

      • Ross
        23. Mar, 2013 at 3:15 pm #

        That’s what I did with P2P lending last year. I started with a few hundred dollars until I felt comfortable. I’ve increased my investment since then, and it’s working exactly as it said it would. That being said, It wouldn’t be a disaster if my whole investment did go to $0 since I know there is a lot of risk involved. I’m still cautious, but it seems to be doing really well so far.

  2. Mrs. Pop @ Planting Our Pennies
    22. Mar, 2013 at 12:10 pm #

    We’re not really ideological about RE leverage. When it makes sense we have it, when it stops making sense, we try to get rid of it.
    For now, we’re trying to pay off the loans on our investment properties. The first was at 6% – and a variable rate at that – too high for us to want to keep it around when we use long term market projections of 6% in most of our models. The second is at 5%, but we owe it to family, which is hard to quantify the impact of, but we’re probably more focused on paying it back soon because of that than if it were to a bank.
    Our last RE loan is on our primary residence. We’re sitting on a 3.25% mortgage that will be paid off in less than 14 years and feel no need to rush it. Will that change later? Maybe, but I doubt it.

  3. writing2reality
    22. Mar, 2013 at 12:19 pm #

    Nice take on a heavily discussed hot-topic in the personal finance world! I totally understand and appreciate the dicotomy that someone with a foot in both the personal finance and real estate realms would experience. I too believe that you can’t just take a stab at what’s best for you, but need to sit down, map it out, and run the numbers.

  4. Michelle
    22. Mar, 2013 at 1:29 pm #

    This is something that we have been thinking about a lot! We “could” pay off our house within the next year, but should we? Should we put all of our money into our house? I’m just not so sure…

  5. Jen of Hens
    22. Mar, 2013 at 1:44 pm #

    This is going to sound odd, but as a person with an illness that will probably take them out early (and has tried already), my priority is “life experiences”. I have a tiny income, but I do manage to save 20%.

    I grew up all over the world because my dad was a civil engineer with USAID. My goal is to travel again and participate in permaculture projects (something I’m passionate about) in Africa and the Middle East.

    And lest you think I’m being irresponsible, I don’t have a family to take care of, and I do have life insurance and am paying down the debt that I do have. But travel is first. I don’t need to be wealthy in terms of cash, but I DO need to be wealthy in terms of experience and sharing knowledge.

  6. Mark Ferguson
    22. Mar, 2013 at 2:42 pm #

    I am a Real Estate investor and not only do I not pay off my personal house any quicker than possible,I don’t pay off my cars any quicker either. Both rates are below 4% and I get returns of 20% plus on just my cash on cash return for my rentals. That doesn’t include principle reduction, tax benefits and apprecitation.

    I do pay off my rental mortgages quicker because they are ARMs and it is hard to get more than four mortgages at a time. My goal is to buy as many rentals as I can in the next ten years.

    Great Article!

  7. Pauline
    22. Mar, 2013 at 3:04 pm #

    I always say that if the bank would lend me more I would invest more so I fall in the invest clan. Being young and healthy I can always bounce back. I chose to pay my primary residence cash though, in spite of the numbers making no sense, I wanted to live in a paid for home.

  8. Nicholas Brack
    22. Mar, 2013 at 3:24 pm #

    Great post Paula!

  9. Name
    22. Mar, 2013 at 5:11 pm #

    Bad math on the two scenarios, no reason to subtract interest, as it’s included in the $739 mo

    A
    Pay 100,000 for house = 100,000 house (or whatever it ends up worth)
    Invest at 7% $739 mo for 15 years = 237,100
    After 15 years – a house and 237,100

    B
    Pay $739/mo for 15 years = 100,000 house
    Invest 100,000 at 7% = 284,894
    After 15 years – a house and 284,894

    Difference is $47,794 + mortgage interest tax benefit

    • Afford Anything
      25. Mar, 2013 at 10:46 am #

      @Name –You subtract interest because you pay more for the house. In Scenario A, you pay $100,000 for the house. In Scenario B, you pay $133,143 for the same house.

    • BMH
      03. Apr, 2013 at 7:21 pm #

      The math is still leaving out the PMI cost or savings, which would benifit option A.

      One other missed point is it is far easier and cheaper to leverage against a paid for house than it is on stocks should you need too.

      • Afford Anything
        04. Apr, 2013 at 2:32 pm #

        @BMH – Afford Anything readers shouldn’t be paying PMI! Everyone who reads this site should be putting down 20 percent on their primary residence, unless there’s a mathematically compelling reason to buy a home immediately.

        • Anne
          11. Apr, 2013 at 2:24 pm #

          I’ve just recently discovered your site and enjoy it a lot, but I have to respectively disagree with you here. Depending on your market and financial situation, you can also view PMI simply as the cost of buying into the market at the current interest rates and prices.

          For example, I live in Vegas, where the housing market started recovering last year. With the interest rates and prices we could get, my fiance and I decided to upgrade and buy our “forever home” that we can raise kids in, host thanksgiving at, etc, and rent out his smaller 3 bedroom. While I transferred over 40k at closing, and while it was significantly more than the lender required, it wasn’t 20% either, so I have PMI on the home. However the 3.375% interest rate and lower purchase cost (based on this market) allow us to have this house at a lower cost than I could buy it for today with 20% down. Say I’d waited another year to finish saving the down payment and the house cost just 10% more- which is actually low, based on more recent sales in our neighborhood- and interest rates were a quarter percent higher, our payments would be more for the same house despite the lack of PMI.

          If you’d asked me 2 years ago when I was saving that down payment I would have told you I’d NEVER consider PMI, but I have no regrets about getting it (though I do intend to make larger payments to get rid of it faster).

          • Afford Anything
            11. Apr, 2013 at 5:44 pm #

            @Anne — It sounds like you made a fantastic decision! I applaud you for doing the math and making a careful, rational choice.

            Many people are scared away from paying PMI for ideological reasons — they’re taught that putting less than 20 percent down on a home is “bad.” But in finance, there’s no “absolute” good or bad. Everything is relative,. Every decision must be compared to other alternatives.

            It sounds like the alternative , in your situation, is less desirable than paying PMI. Sounds you made the right call! The most important thing is to do the math and make those calculations.

            That said, no one knows what the future holds. Housing has been recovering throughout 2012 and continues to recover in 2013. But no one knows what will happen tomorrow. We can take educated guesses, but the future is ultimately unpredictable.

  10. Cherleen @ My Personal Finance Journey
    22. Mar, 2013 at 8:08 pm #

    If I have the extra money, I will do both. I will use half of the extra money to pay extra on my mortgage and use the other half to invest it either on a small business or buy stocks. Hitting two birds in one stone? You can say that.

  11. Kim@Eyesonthedollar
    22. Mar, 2013 at 10:31 pm #

    I think there isn’t a wrong choice. Paying off debt and investing are both wonderful in their own way. It’s whatever makes sense for your personal situation, age, and what helps you sleep better at night.

    • Jake
      22. Mar, 2013 at 10:59 pm #

      I think strippers and champagne would count as the wrong choice :D

  12. Damian
    23. Mar, 2013 at 1:24 pm #

    Pay down debt. Period. I’ve never met anybody that regretted having their biggest debt paid off, even if that meant a little less cash in the bank.

  13. Ross
    23. Mar, 2013 at 3:12 pm #

    I’ve realized recently that I’m way too conservative. If you asked me this question a year ago, I would have told you to get rid of your mortgage first, but I’ve found that leverage can be a powerful tool for good. Like all other tools, it can certainly backfire, but if you handle it properly, it can really help you build wealth.

  14. JoeTaxpayer
    23. Mar, 2013 at 9:09 pm #

    The choice is a tough one. What’s missing from the discussion is the risk in between. Between the aggressive paying off and the final mortgage burning. I’d prefer to have the liquidity.
    My current mortgage is 3.5%, about 2.5% after tax. Do we think the next decade can produce a lost one like the 2000′s? Short of that, staying invested is the right choice.
    For the very, very risk averse, pay the mortgage as fast as you wish, but don’t ignore the matched 401(k) at work. The se accounts have to offer multiple investing options, one of which should be a bond or money market type fund.

  15. Jules
    24. Mar, 2013 at 1:34 pm #

    I’m having the same internal debate regarding student loans. I could pay cash for tuition or invest. I’m allergic to debt but beginning to realize that might not be the best strategy. Spreadsheets and worst-case scenario planning is helping.

  16. Mr. Bonner
    24. Mar, 2013 at 11:54 pm #

    Interesting perspective. To expand on one of the comments above if you itemize and you’re in a 25% tax bracket then the $33K in interest would translate into $8,250 in tax savings.

    What about Scenario D where you go out and buy a rental property with the $100K? ;)

    Also, I totally get what you’re saying about the contrast between personal finance bloggers and real estate peeps. I saw a fee-only financial advisor a couple times and he was all about cash flow. Cash flow this and cash flow that. All I kept thinking about was getting rid of our debt :)

  17. William @ Bite the Bullet
    25. Mar, 2013 at 8:50 am #

    I make 8% on the preferred shares of a REIT, fixed. That’s way more than I pay on my mortgage. I understand the benefits of paying off the last component of our debt, but so far I’ve elected to keep the investment and the mortgage, pocketing the difference and reinvesting it.

  18. Funny about Money
    25. Mar, 2013 at 4:12 pm #

    Hmm… I think it depends on the extent to which you’re in a position to leverage debt. With real estate, that’s a complex issue: where the market is going, how mortgage interest you’re paying, how much income you have, what other kinds of investments you have and how much you’re putting into them, and how much time you have before retirement.

    Over my financial advisor’s nearly dead body (I think he passed out from fright), I paid mine off some years ago. The way I looked at it, that $80,000 invested in the house returned $860 a month in mortgage payments I wouldn’t have to make. If 6% is a reasonable rate of return on investments, then a reasonable return on that 80 grand would be $400 a month: clearly I profited by paying off the shack.

    But the big profit came after I was laid off my job: I would have lost my home if I’d had to make that mortgage payment, and since I’d lost about 30% of investment and retirement savings in the crash, I couldn’t have justified paying it off or even paying $860 a month from savings. Paying off the mortgage when I was able to do so kept me in my home several years later, when disaster struck.

    • Afford Anything
      26. Mar, 2013 at 11:32 am #

      @Funny about Money — That is very, very well-said. Nice synopsis of the issue and the factors at play. And I’m so glad you were able to stay in your home after you lost your job!

  19. nicoleandmaggie
    25. Mar, 2013 at 6:07 pm #

    Here’s us on the topic: http://nicoleandmaggie.wordpress.com/2010/07/31/the-pre-paying-the-mortgage-question/

    We’re big proponents of diversification. Having all your money in your house is itself risky.

  20. Ashley Park
    08. Apr, 2013 at 7:36 am #

    I was always in the investing camp and trying to make as much money as possible but as I’ve gotten older with a family to feed the importance of having that ‘peace-of-mind’ insurance has increased

  21. Seth @ REtipster.com
    24. Apr, 2013 at 12:37 pm #

    I can tell you’ve really thought this through Paula – I like how you give careful consideration to both approaches. This subject kind of reminds me of politics – people get REALLY passionate about their belief system and often times fail to look at the pros and cons of both scenarios.

    This is a great blog, btw. I just discovered it today and I’ll be sure to keep checking in. Lots of great stuff here!

    • Afford Anything
      25. Apr, 2013 at 10:41 am #

      Thank you, Seth! Yes, it’s amazing how conversations about money — especially when it’s in the context of money plus home — becomes as visceral as politics. People could make better financial decisions if they came from a place of reasons rather than ideology, but most people don’t seem to be interested in doing that. :-)

  22. Kross
    15. May, 2013 at 2:58 pm #

    Somehow I’m missing something, I look at this another way, in the past I paid down mortgages mainly for peace of mind, however now I’m sure the best strategy is to allow the mortgage to run its course, consider the following strictly on a ROI basis, this is simplified a bit, but you should get the idea.

    scenario 1) invest 60,000 in GIC’s etc, and right now get a little under 3% if you lock in for 5 years

    scenario 2) take the same money, purchase a 4 unit property for $300,000 (- $60,000 down) = $240,000 mortgage ( 20 year), Lets assume that the property covers all its expenses and maintanance , but has $0 cash flow. Some would say this is not a good investment, but consider this:

    initial investment = $60,000
    term of investment = 20 years
    value of investment at maturity = $300,000
    Return on investment = ($300,000 – $60,000)=$240,000 / 20 = $12,000 year or 20% !!!!

    now if we put in a modest positive cash flow $500/month
    and a modest increase in property value of 1% per year we see the following:

    initial investment = $60,000
    term of investment = 20 yrs
    value of investment at maturity =$366,057 + accumulated cash flow(($120,000) = $486,057

    ROI = ($486,057- $60,000)= $426,057 / 20 = $21,302.85/year or 35.5%

    So by not paying the mortgage off, and letting the tenants pay it off, my ROI on my initial $60,000 is about 35%

    In my opinion there is a huge incentive to NOT pay down a mortgage on a rental/ income property, by paying it down and investing, you are missing out on substantial returns.

    Any Thoughts?

    • Afford Anything
      15. May, 2013 at 6:18 pm #

      @Kross — From a purely “maximizing potential returns” perspective, the best course of action is to NOT pay down the mortgage. From a risk perspective, the best course of action IS to pay it down. (One example of risk: What happens if you face multiple prolonged vacancies in several of your rental units?)

      Having multiple properties defrays some risk. The cash flow from the other 4 properties can cover a vacancy or a massive repair in one of your other rental units. But multiple properties also increases your risk profile in other ways. You can work extra hours to pay the mortgage out-of-pocket on one property, but you certainly could never do that with 16 properties.

      Risk/reward levels should be balanced. I suppose, in theory, I could borrow $5 million at a 10 percent interest rate if I could use it to buy investments that pay 20 percent returns. But if something went wrong, I wouldn’t be able to pay back that note. If I had to personally guarantee that loan, I’d probably get sued, lose all my assets and declare bankruptcy.

      So to defray the risk of that scenario unfolding, I keep limited levels of leverage. The “pay off the mortgage or invest?” question is fundamentally a question about that limited leverage level — how much leverage is optimal? None? Some? A lot?

  23. Sean
    01. Jun, 2013 at 10:34 am #

    What about doing a combination of the strategies outlined in your article?

    Pay off some of your mortgage debt. $50K.

    Invest the remaining money $50K, or keep some as cash for unexpected needs.

    This would reduce some of your debt risk, while still allowing investment leverage.

    (optional) Put some percentage of the $100K into home improvement. ROI is difficult to quantify, but if you plan on living in your house for a while time this can make your home a more comfortable/happier place to live in. Additionally, this can improve the resale value. We have an older home, so this is something I would consider.

    • Afford Anything
      02. Jun, 2013 at 8:08 pm #

      @Sean — That’s what I tend to do! This year, I’m going to max out my 401k and IRA ($17,500 in the 401k, $5,500 in the IRA) and then put the rest towards paying down the mortgage OR making a down payment on a rental property. We’re wrapping up a renovation, and since we also have an older house (it’s 102 years old) the remodel was very, very much needed.

  24. Peaceofmind
    14. Jun, 2013 at 9:38 am #

    Sorry, but being a mother of two…I’ll take peace of mind any day. I overpay my mortgage, have refinanced twice from 6% down to 2.76% and went to a 15 instead of 30. Having the looming feeling that any day we could lose our jobs makes me worry about not being able to make mortgage payments and having to cash out my retirement to pay bills. That’s always a last resort but one I don’t want to make unless I’m at risk of losing my home or not feeding my kids. The idea of not having to worry about a heafty mortgage payment every month or if we lose our jobs tomorrow that the house could be the first to go…I’ll take peace of mind. I think the scenerio is different when you have a family to provide for. I don’t own an expensive home by any means but we built it new and the idea of having it yanked out from under me and my children makes me ill. It’s happening to everyone we know and sadly, these people didn’t owe that much on their mortgage and had lived there for 15 years and bang…forclosure…if I owned my house outright and lost my job tomorrow, all I would have to worry about is making enough to buy groceries and pay utilities and a few other things and not rely on welfare. We have a 6 month backup in savings and zero credit card debt and no car loans. Kids have college savings I contribute monthly, I max out my work retirement account, and I have a separate Roth I put a little in monthly as well as my husband. We make less than 1% on our backup savings. We did the stock market a few years and LOST money…so I’ve learned a peace of mind is worth 100% in my book and my children’s sake. When it’s paid off I’ll take that $1300 a month I paid and invest it. Maybe I’ll get 5% interest in a money market like I was back in what…2009?!?!!? If rates were better in safe investing, I would put that money there instead but that’s not the case and I don’t see rates going up anytime soon so I’d rather stick it in the house and sleep better at night.

  25. Nicolas
    22. Jun, 2013 at 5:27 am #

    I’ve been googling the stocks vs home-ownership dilemma a lot and this article explains the issue far better than anything else I’vve come across. Seriously, why can’t other bloggers journalists and bloggers make it this simple? Thank you!

  26. Practicalandrealistic
    09. Jul, 2013 at 2:09 am #

    Lost $ 5k in stocks in a short period of time..and that was 5k worth of investing lesson and life lesson to me! I learned a lot! Never ever really gamble more than what you can afford to lose. Investing in the market is never stable..it’s no different than placing a bet..you can win and you can lose. I prefer to pay-off one of my basic needs..shelter. If you lost your job tomorrow, psychologically, you won’t really think and say: Oh at least my 100k grew by 10% from investing in stocks. You would rather that you paid off your house. That is one less stress for you.
    Especially if you have dependents and minor kids, you don’t just want to uproot them and move like a rolling stone because you cannot afford a place. Kids need stability. Just my opinion…..

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