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When you end up with extra cash, whether it’s through a windfall or an adjustment to your monthly budget, figuring out how to put that money to best use can feel like a daunting task.
One decision you might be contemplating is whether to pay off your mortgage with the new money or invest it. While neither option is a poor financial choice, there are benefits and drawbacks to both.
Here’s what you should consider when deciding between paying off your mortgage or investing:
- Consider your tolerance for risk
- The case for paying off your mortgage
- The case for investing
- How to decide between paying off your mortgage or investing
- Other uses for your extra funds
- Another option: Refinance to a shorter loan term and invest
Consider your tolerance for risk
You need to know your own comfort level when it comes to the risks involved with homeownership and investing. Here’s how the two options generally differ in terms of risk:
- Homeownership: In general, homeownership is considered less risky than stocks and other investments, since real estate often appreciates steadily over time. However, you also run the risk of having to sell in a down market, and you could still lose money if property values in your area drop.
- Investments: Stocks and other investments tend to be riskier investments because prices can be more volatile, with more frequent market crashes. If you have a higher risk tolerance, though, stocks typically rise in value faster than real estate.
On the other hand, the S&P 500 saw an annualized return of 13.84%, including dividends, over the past decade, from July 2010 to July 2020, according to The Wall Street Journal.
The case for paying off your mortgage
There are several reasons why you might want to consider paying off your mortgage early versus investing any extra money:
- Save on interest costs: The faster you pay off your mortgage, the less you end up paying in interest overall.
- Peace of mind: Knowing you don’t have this debt hanging over your head can help you feel better about life and your situation.
- Tangible asset: Your home is a tangible asset that you can live in. The faster you pay down your mortgage, the more equity you build in the home, which can net you more cash in the end should you decide to sell.
Refinancing can also help you achieve this goal faster. If you have more money in your budget, consider refinancing to a shorter term with a lower interest rate. You can pay off your mortgage more quickly while saving money on total interest charges — just keep in mind that your monthly payment will be higher as well.
Credible can help you with your next mortgage refinance. With Credible you can compare prequalified rates from all of our partner lenders in just a few minutes.
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Counterpoint: Since real estate tends to appreciate more slowly than stocks, you could miss out on significant market gains from other investments should you decide to throw all of your extra cash toward your mortgage.
Learn More: When to Refinance a Mortgage: Is Now a Good Time?
The case for investing
Instead of paying off the mortgage, you could put some of that extra money into investing. Some of the advantages of this option include:
- Higher rate of return: On average, investing has the potential for a higher return than paying off low-interest debt like a mortgage.
- Build wealth for the future: If you invest in a tax-advantaged retirement account with the extra money, there’s a bigger potential for a larger nest egg in the future, thanks to compounding returns and tax-efficiency.
- Increased liquidity: When using a taxable investment account, such as a brokerage account, to invest in the stock market, you have more liquidity. If you need access to capital, it’s easier to sell stocks and access cash than it is to tap into the equity in your home.
Counterpoint: Because stocks aren’t backed up with something tangible, like a home, and due to price volatility, you could see dramatic drops in your portfolio, which could result in losses if you sell during a crash.
How to decide between paying off your mortgage or investing
Before deciding to pay off your mortgage or invest, it’s important to consider your own financial goals and priorities, and decide what matters most to you.
Here are some factors to mull over before you make a final decision:
- Return: The stock market is likely to provide you with better long-term results. Gains often outweigh interest savings from low mortgage rates, and home appreciation in most areas doesn’t keep up.
- Comfort level with debt: If your main motivation is to be completely debt-free, then it might be worth paying off your mortgage first, if only for that peace of
- Retirement: Think about your timeline for retirement. Depending on the situation, it can make sense to invest and build a retirement portfolio, especially if you can still pay off your home by retirement without aggressively tackling the mortgage.
- How long you plan to stay in the home: It might make more sense to pay off the mortgage instead of invest if you plan to stay in the home long-term. But if you know you’ll be moving in a few years, and your interest rate is low, you might be better off holding onto the cash or investing it.
Putting $1,000 toward your mortgage vs. investing it
Let’s run through a couple of scenarios showing what might happen should you put an extra $1,000 toward your mortgage or the stock market.
Say your mortgage balance is $200,000 with an APR of 3.25%, and you have a monthly principal and interest payment of about $870. If you put an extra $1,000 toward your mortgage each month, you could pay off your home in 10 years and six months and save $77,300 in interest.
But if you invested that $1,000 in a fund tracking the S&P 500 index, you’d likely see a far greater return. Assuming a 10% annual return, you’d end up with $191,249 in the same time frame. That’s more than double the amount you would have saved on interest had you decided to put that money toward your mortgage.
Credible is not an investment advisor, so be sure to speak with an investment specialist beforehand to see if the numbers work for you.
Other uses for your extra funds
Sometimes it’s not just about paying off your house or investing. Depending on your financial circumstance, there might be better uses for your money. Here are some other options you might consider.
Build out your emergency fund
If you don’t have an emergency fund, consider beefing that up with your extra money. That way, you’re less likely to need to tap into your home’s equity or liquidate your investment account in an emergency. Your emergency fund can help shore you up against problems in the future.
Pay off high-interest debt
Tackling high-interest debt, like credit card debt, before paying off the mortgage or investing might be your smartest financial decision. A high interest rate on your credit card can cost you more in the long run, and stock market returns rarely beat high interest rates on debt.
Another option: Refinance to a shorter loan term and invest
Think about refinancing your home loan to a shorter term. If refinance rates are low, and you cut your term down to 15 or 20 years, you can potentially save thousands in interest and be done with your mortgage sooner.
Plus, you might still have some money left over each month to invest, giving you the best of both worlds. Review your options to see what’s available, and what’s most likely to benefit your financial situation.
Keep Reading: How to Refinance Your Mortgage in 6 Easy Steps
If you think refinancing is the right move, Credible makes it easy. You can compare multiple lenders and see prequalified rates in as little as three minutes without leaving our platform. Use the table below to get started.
