Invest or Pay Down Your Mortgage Quicker - Which is Better?

by Marsha Charles 12/27/2020

Photo by Andrey_Popov via Shutterstock

Often, when discussing ways to get out of debt, the subject of “mortgage versus investments” comes up. If you have a mortgage, your monthly budget likely revolves around paying it first, meaning investment ideas take a back seat. One way to free money up to invest is to pay off the mortgage, and many financial planners advocate for paying off the mortgage if you can with any available funds. Others suggest that by not investing extra cash, you miss the benefit of compounding interest your investment can earn over those same years. So, which is better? That depends.

How It Works

Ultimately, the question comes down to how it affects your bottom line. But when it comes to investing versus mortgage payments, the first place to investigate is how it changes your tax return. Find an online tax calculator to calculate which one saves you more or if you break even.

Next, look at the concept of “opportunity cost” to determine which could save you more. An opportunity cost is a comparison of what you could gain by using a specific amount to pay down your mortgage or invest that same amount. If you have $500 extra to either invest or apply to your mortgage, for example, you might earn four percent on the investment, or $20. After taxes, those earnings would be $15.

If you use the $500 to make an extra payment on your mortgage and your loan is at three percent interest, it saves you $15, and after taxes you might have $12.50. In this case, the investment would net you more. Of course, each of these numbers adjusts based on your true rate of return compared to the interest rate paid, and the tax bracket it puts you in for the year. That means that while this year it’s better to invest, next year might be better to pay on the mortgage.

Remember These Guidelines

  • If your mortgage rate is low, the long-term benefit from paying it off early decreases.
  • When the choice is between your mortgage and adding to your 401(k), often the retirement plan is better because of compounding interest over time.
  • If you move into a lower tax bracket, it’s better to pay off the mortgage.
  • If your investment returns decrease, such as in the 2008 downturn, it’s better to pay off the mortgage.
  • Calculate your level of risk tolerance. If increasing risk to get a greater return causes stress, concentrate instead on paying down the mortgage. That way, your home is never in jeopardy due to your investment risk. 

Even if a plan seems perfect this year, revisit your decision every year or two to see if you need to switch out your plan. 

About the Author
Author

Marsha Charles

Consistent top listing and selling agent receiving Chairman's Club award for superior sales achievement almost evey year while associated with Preferred Properties, Inc. Consistently receive the International Presidents Premier award for sales volume since joining Coldwell Banker Residential Brokerage and ranked in the top 1% of agents in Connecticut and Westchester County. Received recognition as a Top Five Sales Recepient for customer satisfaction since 2010 and listed in Westchester and Connecticut Magazine. Member Top Agents in Connecticut listed by Real Trends. Works with Sellers and Buyers with a strong understanding and attention to needs of those who are relocating . Background and experience in advertising, public relations and photography offer creative and innovative marketing plans for sellers. Realtor designations include: Graduate Real Estate Institute, Certified Residential Specialist, Certified Residential Marketing Specialist. Served as President of New Canaan Board of Realtors,Currently serve as director of the New Canaan Board of Realtors and chairman member of the Professional Standards committee. Named Realtor of the year by the New Canaan Board of Realtors. Married and the Mother of four children who attended and graduated from the New Canaan School System .Member of New Canaan, Darien, Greenwich and Statewide MLS systems. Areas covered include New Canaan, Darien, Greenwich, Rowayton,Norwalk, Wilton and all of lower Fairfield County.