Should You Pay Off Your Mortgage Early or Invest?

Mortgage debt reached an all-time high in the U.S. at the end of 2021, climbing to a staggering $10.31 trillion, according to recent figures published by the credit bureau Experian. If you have some extra cash in your pocket, your first thought may be to work toward getting your portion of that tremendous debt burden off your back. But is it really smart to pay off your mortgage early, or would it be better to invest those funds?

As is the case with most financial questions, the answer depends on your unique situation. We delve into the specifics to help you assess whether you should pay off your mortgage or invest. (Spoiler alert: You don't necessarily have to choose just one).

When making the decision of whether you'd be better off just paying off your mortgage or investing that cash, there are several factors to consider:

• Mortgage rate: The first factor you'll want to consider is your mortgage interest rate. If your rate is low, (say, below 3% or 4%), you may not be as worried about paying it off in a hurry. On the other hand, if you have a high rate (say, 5% or higher) and are unable to refinance, you'll end up paying more in interest on your mortgage by not cutting down the time you take to pay it off.
• Current ROI: You'll also want to consider your return on investment, or ROI, for any investment accounts you have or are considering opening. If your ROI is higher than your mortgage rate—for example, you're paying 3% on your home loan and earning 8% on your investment account—you could earn a greater return by investing as opposed to paying off your mortgage. However, you'll want to keep in mind that no returns are guaranteed.
• Your risk tolerance: Your tolerance for risk is another important consideration. Investing is risky, given the ups and downs of the markets. If you tend to stick to more conservative investments or don't have the stomach for riskier bets, your return on investments might not trump your mortgage rate by all that much.
• Your feelings around having debt: Some people can handle sitting in debt more easily than others. If your mortgage feels like a weight holding you down, you may prioritize paying it off to release that emotional burden.
• Whether you'll need quick access to the cash: Paying off your mortgage will rapidly deplete your cash reserves. If you think you might need quick access to your cash, or if your emergency fund isn't as much of a cushion as you'd like it to be, you may want to consider a more liquid investment that could easily get converted to cash in a pinch.
• When you plan to retire: Last but certainly not least, you'll want to keep in mind how soon you're planning to retire. If retirement is on the horizon, it may be helpful to eliminate your monthly mortgage payments from your plate so you can put those funds toward other expenses as opposed to taking risks with the stock market.

Wondering what the arguments in favor of paying off your mortgage early are? Here are some of the benefits of putting your extra cash toward a mortgage payoff: 

• Your returns are guaranteed: When you pay off your mortgage early, you'll know for sure what your returns will be—the interest saved from making your payments ahead of schedule.
• You'll get peace of mind: Especially if you're someone who's unnerved by debt hanging over your head, paying off your mortgage can lift a weight off your shoulders.
• You're gaining equity that can be accessed in the future if needed: When you pay off a chunk of your mortgage early, you'll then be able to use that equity for a down payment on a future home, when an upgrade is needed or to cover an emergency. This is possible through home equity loans and lines of credit, which use the equity value of your home as collateral for a new loan or line of credit, or through cash out refinancing, which lets you access your home's equity by replacing your current mortgage with a new loan of a higher amount.
• You'll free up monthly cash flow: By paying off your mortgage, you'll ditch those monthly payments that can cut into your budget. While you can increase your cash flow through investing as well, the benefits likely won't be as immediate.
• You could benefit if you have an adjustable-rate mortgage (ARM) and rates are currently low: One scenario in which paying off your mortgage could be especially beneficial is if you have an adjustable-rate mortgage, which is a loan where the interest rate fluctuates. If your rate is currently low, it might be worth seizing on that and paying off your mortgage quickly.

Opting for investing over paying off your mortgage has its benefits too. Here are the pros of investing instead:

• You'll have the potential for higher returns: Investing offers the potential for higher returns than paying off your mortgage. For instance, the stock market has generated an average annual return of 8% between 1992 and 2020, while U.S. farmland investments have had an average annual return of 11% within that same timeframe. However, returns are never guaranteed and don't necessarily stick close to the average. Even a relatively low-volatility investment like farmland still has a volatility of 6.90%.
• You can reap the benefits of compound interest: Due to compound interest, the earlier you invest, the faster your nest egg will grow as long as earnings are reinvested.
• You might have easier access to your money: Putting your money in the stock market as opposed to your mortgage payments might offer easier access to your money. Of course, this also depends on the liquidity of your investment (for instance, a mutual fund is a much more liquid investment than real estate property). While you can access cash from home equity, it's not a guarantee. Selling off stocks, for instance, is often an easier way to get cash in a pinch.
• You could enjoy additional tax benefits: When it comes to tax benefits, paying off your mortgage early isn't always as advantageous as investing. This is because mortgage interest is tax-deductible—once you pay it off, you won't be able to take that deduction anymore, so you'll need to do the math and figure out if that's still better than investing. Plus, if you invest those funds into a tax-advantaged retirement account, you get additional tax benefits.
• You can better take advantage of employer matching programs: By investing more money in a company-sponsored retirement plan, you can take greater advantage of any employer match offered. Often employers will match a percentage of your contributions, up to a certain percentage of your salary, which is effectively free money that's yours for the taking.

Now that you know the arguments for both sides, it might also help to take a look at the cold, hard numbers to make the final call on whether to pay off your mortgage or invest.

Let's assume you have a 30-year, fixed-rate mortgage for a home with a purchase price of $450,000, and you made a 20% down payment. Your rate is 3.043%, the current average 30-year fixed rate. You have an extra $250 in your budget that you could spend each month.

If you were to put that $250 toward your mortgage payments, you would save approximately $43,414 in interest. 

On the other hand, if you were to invest $250 a month for 360 months (the amount of time it would take you to pay off the above mortgage without extra payments) at an annual return of 8.29% (the average annual return for a portfolio of 50% equity and 50% fixed income, per Vanguard), you would earn $111,189 in compound interest, accounting for taxes and inflation and assuming you started out with an initial investment of $0.

Of course, investment returns rarely adhere to the average. Per data from Vanguard, the worst-ever annual return for the previously mentioned asset allocation was -23.49%, and 18 of the 94 years Vanguard looked at saw losses as opposed to gains. And unfortunately, no one can predict exactly how the market will perform going forward.

This is certainly the case outside of stock market investing as well. For instance, you could have invested in Bitcoin early and sold when it hit an all-time high of more than $64,000 in April 2021, multiplying your money enough to afford a second home. Or you could have suffered a massive loss, as Bitcoin's value dropped to under $30,000 just a few months later.

In other words, investing might have the potential to produce higher returns, but don't bet on any certain outcome.

Of course, you don't have to choose between paying off your mortgage and investing—as they say, you can walk and chew gum at the same time. If you're interested in paying off your mortgage and investing at the same time, here are a couple of potential approaches to consider:

1. Refinance to get a lower rate and invest the extra cash: One way to make it easier to both invest and pay off your mortgage is by refinancing your mortgage to a lower rate. By paying less in interest each month, you'll have extra funds to invest if you'd like, and it will be easier to pay a little bit more toward your mortgage as well.
2. Split up your extra funds between your mortgage and investment accounts: An easy solution to the mortgage versus investing conundrum is splitting the difference. You could divvy up your extra funds, putting some toward your investment accounts and the remaining cash toward your mortgage to pay it off a bit earlier.

As you can see, there's a lot to consider when deciding whether you want to pay off your mortgage or invest—or do both. If you're only looking at things from a financial perspective, investing can often net you greater returns than focusing only on paying off your mortgage—unless, of course, you have a particularly steep mortgage rate. 

But financial decisions aren't only about the numbers. To make the right decision, you will also need to take into account your personal goals and preferences, including your risk tolerance and how you feel about carrying around debt.