One of the most debated topics in personal finance is whether it makes more sense to pay your mortgage off early or invest extra cash. There are advantages and disadvantages to both options, and at the end of the day, there may not be one solution that is best for every situation. No matter which choice you make, to prepay your mortgage or invest extra money, you need to make a decision and then remain disciplined enough to continue your preferred course of action.
Advantages of Paying Off Mortgage Early
The primary reason most people pay the mortgage off early is for the peace of mind that comes from knowing the house is completely paid for. Being debt free is one of the most important steps in becoming financially free.
But there is another great benefit of paying your mortgage off early. When you prepay a mortgage, you can save tens of thousands of dollars in interest. Once paid off, you also have extra money each month that you would have sent to your mortgage otherwise. You can then use the mortgage payment to invest, pay off other debts faster, or otherwise apply it toward reaching your financial goals.
Disadvantages of Paying Off Mortgage Early
While paying your mortgage off early gives you peace of mind and interest savings, the argument from people who think investing is a better use of extra money is that mortgage interest rates are usually quite low. A portion of your mortgage payments are also tax deductible if you itemize your tax return, which means paying off your mortgage early may not be as advantageous as it seems at first glance. That said, it almost never makes sense to keep debt for a small tax savings.
Advantages of Investing
Because mortgage interest rates are usually comparatively low, it may be better to use extra money toward investments that have a potential for larger returns. When you use the money to pay extra on the mortgage, you give up investment returns that are probably going to be higher than the interest you’re saving by paying the mortgage early. For example, if your mortgage is charging 5% fixed interest over the life of the loan, and you could earn 8 to 10% returns on money invested, obviously the money is better used on investments than paying the mortgage early.
Disadvantages of Investing
There are no guaranteed returns when you invest money. You can only assume the average return, but you might find you expected an 8% return on your investments only to earn 4% – in which case you may have been better off paying your fixed-interest mortgage off early instead of investing.
A blended approach may work
If you have extra money, you can use both approaches. For example, my wife and I round our mortgage payment up to the nearest $100. Our mortgage ends in the twenties, so we send over $70 extra per month toward the principal. We have been doing this for over 4 years now and have cut thousands of dollars off our principal and several years from our repayment schedule. The difference is small enough that we don’t notice it on a monthly basis, and still allows us to max out our IRA contributions, make 401k contributions, and have a little fun money.
Discipline and Consistency is Key
Regardless of which you choose to do, the issue many people face when deciding to use extra money to invest rather than paying off their mortgage early, or to use your extra money to pay the mortgage off early – is a lack of discipline. If you decide to invest the extra money but don’t stick to the plan, now you’ve wasted money you could have used for paying off the mortgage early – or money you could have used for investing in your future.