Business_news Should you pay off your mortgage early or invest? We did the math to find out which nets a greater return

Business_news

Deciding whether to pay off your mortgage early or invest?

Caiaimage/Chris Ryan/Getty


  • Whether topay off your mortgage earlyor invest that money instead is a hotly debated topic among US homeowners.
  • We consulted a certified financial planner to run a simulation for a hypothetical homeowner with a 30-year mortgage who has extra income to spend.
  • The deciding factor is interest rates: If the rate on your mortgage is higher than what you might make by investing the cash, pay down your debt first.
  • We made several assumptions for this scenario. Consider your own unique financial situation if you’re weighing a similar decision.
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Debt can often be a thorn in your side on the path tobuilding wealth, but it’s not all bad.

Still, if you’re a homeowner with amortgage, you’ve likely weighed the decision to pay it off early, if you can afford to. It’s a worthy goal to be free and clear of all debt, but is it the right choice if you’re trying to optimize your every dollar?

Business_news A financial planner’s recommendations

We consulted Brian Fry, a certified financial planner who foundedSafe Landing Financial. He said the answer really depends on the specifics of the situation, but generally the biggest factor in deciding whether topay off a mortgage earlyor invest your extra cash from a windfall, salary raise, or some other source is the interest rate.

Here are his high-level recommendations. Scroll down for the full set of assumptions he used. 

  • Best action:Refinance and invest more aggressively, because a 15-year fixed mortgage with a rate of 3.19% is much lower than the market’s expected rate of return.
  • Second-best action:Refinance and pay the mortgage aggressively. If the homeowner doesn’t agree with long-term investment-return estimates and would rather act more conservatively, they can pay off the mortgage and then invest and still come out OK.
  • Third-best action:Don’t refinance and pay the mortgage more aggressively. The homeowner will be debt-free 99 months sooner by putting an extra $24,000 a year toward the loan balance.
  • Worst action:Don’t refinance, don’t invest, and spend the extra cash instead. If the homeowner did not refinance and decided to spend the money, they would not have extra retirement savings, if that’s their goal.
  • Second-worst action:Don’t refinance, and still invest the extra cash. A 5.84% interest rate on the loan is higher than the market’s expected rate of return. If the homeowner is locked into a higher interest rate, it’s best to pay off the debt first.

Business_news The bottom line: Look at interest rates

If the rate on your mortgage is higher than what you might make by investing the cash, it’s often better to pay down your debt before investing more, Fry said.

That is, unless you considerrefinancingto secure a lower rate, he said. In fact,refinancingcan be a good option whether or not you ultimately decide to pay your mortgage aggressively. Interest rates fluctuate and they’recurrently at historic lows, so be sure you shop around before making a decision or running your own numbers.

But Fry said it’s also crucial to look at how far you are from retirement, how long you plan to stay in the home, whether you have other high-interest debt, the possibility oftax deductions, and the status of youremergency fundandretirement savings. There are non-financial factors to think about as well.

“It’s really important to have a good understanding of what you’re trying to accomplish before determining the best course of action,” he said. And if you need help, a fee-onlyfinancial plannercan be a great resource, he said. 

To help illustrate the debate between paying off your mortgage early versus investing, we asked Fry to run a simulation. Below are the assumptions he used, which are based on historical, not current, interest rates:

Business_news Methodology

The hypothetical

A homeowner just got a raise that will net them an additional $24,000 a year after taxes. They plan to stay at this job, and it’s unlikely they’ll get any more raises or cost-of-living adjustments. (This figure was used for the purposes of this calculation; a smaller raise or windfall would yield similar results.)

They have an establishedemergency fundand no other debt, and they’re already maxing out their401(k)andIRA. They plan to stay in their home forever and retire in 15 years, at 65.

Their initial mortgage balance was $400,000 on a 30-year fixed-rate loan with an interest rate of 5.84%. They are 15 years into their mortgage and have a remaining balance of $282,221.

If they refinance to a 15-year fixed mortgage, their interest rate would be 3.19%. Refinancing costs are estimated to be $6,000, for simplicity. Generally, refinancing costs are 1.5% to 4% of the remaining mortgage balance.

Their nest egg is diversified, and they are looking to make the best financial decision about how to use the extra income to maximize their wealth. Do they use this extra money to pay off their mortgage more aggressively, or invest more aggressively?

The calculation

Fry used Right Capital, a financial-planning software, to calculate how much the homeowner would have in a taxable investment account in 15 years using a straight-line analysis.

The variables are whether they refinance their mortgage, and whether they put their additional income (and savings from refinancing, if available) into an investment fund or put it toward their loan balance.

Fry used theVanguard Total Stock market Index Fund, which has a long-term annual return of 5.38%, according to JPMorgan estimates. He said it’s important to remember that the market doesn’t go up by the same percentage every year: Some years offer better returns, while others may have negative returns.

Invest more aggressively:

  • If the homeownerrefinancestheir mortgage and invests what they save on monthly payments plus $24,000 a year, in 15 years they will have paid off their mortgage and have an investment-account balance of$623,701.
  • If the homeownerdoes not refinancetheir mortgage and invests the $24,000 a year, in 15 years they will have paid off their mortgage and have an investment-account balance of$533,099.

Pay mortgage more aggressively:

  • If the homeownerrefinancestheir mortgage and uses the amount they save on monthly payments plus the $24,000 additional income to pay it down more aggressively and then invest, in 15 years they will have paid off their mortgage and have an investment-account balance of$599,662.
  • If the homeownerdoes not refinancetheir mortgage and uses the $24,000 additional income to pay it down sooner and then invest, in 15 years they will have paid off their mortgage and have an investment-account balance of$572,449.

Disclosure: This post is brought to you by the Personal Finance Insider team. We occasionally highlight financial products and services that can help you make smarter decisions with your money. We do not give investment advice or encourage you to adopt a certain investment strategy. What you decide to do with your money is up to you. If you take action based on one of our recommendations, we get a small share of the revenue from our commerce partners. This does not influence whether we feature a financial product or service. We operate independently from our advertising sales team.


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