Invest or Pay Down My Mortgage?
This is a question that many are asking. There are actually two schools of thought on this, so I'll briefly explain both and then share what I advise my clients to do.
If you want to address the question from a purely mathematical standpoint, and we assume that your mortgage has a low fixed rate, then simple math dictates that investing for the long term will most likely win. This is because investment appreciation is out-pacing the low mortgage rates of today's market. In other words, you stand to gain more return in the market than you will pay in interest on your mortgage, so your money would be more efficiently used to invest.
The other option is paying down your mortgage debt first, which gives you a very measurable goal and avoids the risk that inevitably comes with investing. Every dollar that you put towards reducing your mortgage principal is a guaranteed rate that you don't have to pay interest on. The rationale is that by paying off your mortgage, you are significantly increasing your monthly cash flow. And many people link retirement goals to when their mortgage will be paid off. They assume that in retirement they will downsize, sell their home, and use the equity to supplement their income. In reality, most people actually decide to keep their home or downsize in square footage but NOT in their mortgage amount.
So here's what I like to remind folks of:
1. Only about 70% of the cost associated with your home is actually principal and interest. The other 30% is taxes, insurance, and upkeep. Even if you pay off your mortgage completely, you're still going to be left with that 30%. So, yes, paying off your mortgage will free up some monthly cash, but given the fixed costs of owning a home, it may not be as much as you think.
2. You can't spend the money that's tied up in your house. Once you pay off your mortgage, the only way to get access to the equity is to borrow again or sell your home. So let's say you're finally ready to tackle the remodel you've been dreaming of; chances are, you're going to end up with some sort of mortgage again. That just begs the question: what was the point of foregoing the investment appreciation to pay down your debt if you were just going to walk back into debt down the road anyway?
I do acknowledge that there is an emotional human connection to answering this question. As with many financial considerations, decisions aren't always based on math. It has been my experience that paying down a mortgage -- regardless of how the math works out -- makes people feel more secure. The emotional benefit of your mortgage decreasing right before your eyes in black and white every month has a value that can't be measured in dollars and cents. It just feels good! You get to see the numbers reflecting that you are steadily on your way to achieving your goal, and that's a win.
On the other hand, investing for the long-term is somewhat intangible. After all, even though you get to enjoy the market that brings you a steadily increasing portfolio, you also have to endure the market that's declining. In fact, that's the very nature of investing for the long haul. You may know it's the right thing to do, but it just doesn't feel as good as the steady climb towards your goal as with paying down a mortgage. It's like enduring both the incoming and outgoing tide regardless of which way you're heading. You'll eventually reach your destination, but it sure does feel better when the tide is pushing you along as opposed to moving against you.
What do I advise my clients to do? Typically, it's a bit of both. First, I say to take advantage of proven market growth and invest for the long-term. Then, when you have extra cash, whether from monthly cash flow or perhaps a bonus, allocate at least some of those dollars toward reducing your mortgage debt.
Keep in mind that there are highly individual nuances in each person's scenario, including your tax rate, your investment allocation, and the amount you're saving. Any of those can impact the way you might allocate your money. One of the advantages of working with a professional is that we have the tools and knowledge to answer this sort of question specifically and accurately just for you.
P.S. Feel free to email me if you have specific questions you need help answering.
P.P.S. We cover this topic in greater detail in this blog post.