So you have come into a windfall or you just received a raise, or you have paid down your debt and suddenly have extra cash flow each month. What a fantastic problem to have.
While the peace of mind of paying off your mortgage can not be understated, it is not advantageous to your overall net worth. The amount you would save in interest by paying off your mortgage early will be far exceeded by what you would earn investing
Why pay off the mortgage
I myself have struggled with the decision of investing vs paying the mortgage off early. While I ultimately decided to Invest, the best reason I could come up with to pay off the mortgage early is peace of mind.
If you are here reading this article, odds are you have personally experienced the anxiety that comes along with the bills piling up, being in debt, struggling to pay the bills, worrying about the future, etc. I can still remember the feeling I had writing the final check to pay off my student loans. I felt like Andy Dufresne in the Shawshank Redemption tearing off his shirt in the rain after crawling through a sewage pipe to earn his freedom. I can only imagine I will experience a similar feeling once the mortgage is paid off.
Why I invest instead of paying off my mortgage
Have you ever been stuck on the side of the road wth a busted car and no money in your pocket? You start to wonder: . How will I get to work? How will I get to work tomorrow? I don’t have money to get this fixed let alone a new car. I barely have enough money for lunch.
While the feeling peace of mind that comes along with having no debt is important, the security in knowing you have liquid funds available is even better.
I still drive a cheap car but if I know if it breaks down I can quickly repair or replace it. Not paying off the mortgage early has allowed me to instead use that money to build a liquid emergency fund and invest in assets that grow more quickly due to compound interest.
One other strategy is to buy high yield dividend stocks in the hopes of accumulating enough to live off the dividends they pay. Check out the article I wrote on this topic for more details about living off dividends in retirement.
Pay off Mortgage vs Investment over 30 years
The typical mortgage lasts 30 years. Interest rates today are in the 3 -4 % range. A mortgage of $250,000 at 3.5% interest over 30 years will have a monthly payment of about $1200 and will cost you an additional $154,000 in interest over the life of the loan. Lets assume you will put an extra $1000 a month towards the mortgage in the hopes of early payoff. You now take the life of the loan down from 30 years to 13 years and save nearly $100,000.
Sounds great, but check out the table below and lets see what would happen if instead of putting an extra $1000 towards the mortgage, we invest it in a simple Index Fund that earns 6% over those same 13 years.
I know very few of us can afford to pay cash for our house, but if you could would you, or would you invest that money instead? Column 2 will look at what would happen if you invested $250,000 (the full cost of the house) over 13 years.
| End of Year | Invest $1000 at 6% | Invest $250,000 at 6% |
| 1 | $12,300 | $265,000 |
| 3 | $39,250 | $$297,750 |
| 5 | $69,500 | $334,500 |
| 10 | $162,473 | $447,750 |
| 13 | $232,750 | $533,000 |
As you can see, if you have the cash on hand, it makes far more sense to invest it rather than buy a house with it. That is unless you think your house will more than double in value in 13 years and then you plan to sell it.
Lets look at one more table, just because these are so much damn fun for me to create. Lets compare the individual who decided to pay off the mortgage vs the saver over the full 30 years. So the mortgage payer offer pays off the mortgage early using an extra $1000 a month and after that invests the $1000 plus his $1200 mortgage payment each month for the rest of the 30 years. So they save nothing for the first 13 years but then save $2,200 a month for the next 17 years.
The saver will simply invest $1000 over 30 years instead of paying off the mortgage. At the end the person paying off the mortgage will have saved about $100,000 in interest payments that the saver did not but the rest of the mortgage payments will be equal. They each earn 6% on their investments.
| End of Year | Pay off early | 30 Year saver |
| 13 | 0 | $232,750 |
| 20 | $227,000 | $453,500 |
| 25 | $457,500 | $676,250 |
| 30 | $765,000 | $974,500 |
As you can see, while the person paying off the mortgage early may have saved $100,000 in interest payments, in the long run they end up with over $200,000 less than the saver.
Conclusion
OK Last table I promise. (Boy these are fun) Instead of a simple pros and cons menu this will be pros vs pros. Pros of paying the mortgage vs pros of investing instead.
| Pros of paying mortgage early | Pros of investing |
| Peace of Mind | Compound interest growth |
| More monthly cash flow | Building Liquidity |
| Investments will outperform mortgage interest costs | |
| Money in the bank (You cant go out and spend home equity) | |
By now I have made my stance on this issue clear. I personally prefer to have the liquid assets that are available to me. I also feel there is more potential for greater earnings in investing than paying off the mortgage. That is not to say that paying your mortgage off early or even up front is a bad thing. The important thing is that you are putting that money towards your financial independence and not giving it away by spending it on stupid shit.
Thanks for reading and be sure to check out my article on Why an Emergency Fund is so important and how to build one.
Earl