Pay off mortgage or invest: How to make the right choice

Planning for the future or celebrating a well-earned raise? Deciding how to use your extra dollars is an exciting opportunity to invest in your goals.

It makes sense that homeowners want to prioritize paying down their mortgage debt, but is it better to invest extra cash elsewhere first? Before deciding to either invest or pay off your mortgage, explore the pros and cons of each – or do both.

Should you pay off your house or invest?

Choosing to pay down your mortgage or invest in your future depends on your personal financial situation.

If you’re thinking of paying off your mortgage early, you’ll want to consider:

• Your current priorities: Consider how much it would cost and if the money you would save in interest and having less debt matters more to you than putting away money to build your future wealth.
• How much of your mortgage is paid off: It is typically smarter to pay as much as possible early on to avoid ultimately paying more in interest. Putting your money into retirement accounts or other investments may be more valuable if you are in or near the later years of your mortgage.

If you are uncertain about investing a lot of money in a place where your rate of return is not guaranteed, investing all of your extra cash isn’t the right move. Your decision should reflect your financial situation and the choices you are most comfortable making.

Pros and cons of paying off your mortgage first

It can be enticing to think about completely paying off your mortgage, owning your home, and being debt-free — at least regarding monthly mortgage payments. However, paying off your mortgage early can save you thousands of dollars overall and is often a solid financial decision.

If your income has increased and you are still in the early years of your mortgage and making payments that go primarily toward interest, paying off your mortgage first might be the best option.

Pros of paying off your mortgage

Paying off your mortgage comes with possible or inevitable advantages.

Interest savings

If you pay off your mortgage ahead of schedule, you can potentially save thousands of dollars in interest you would have paid if you hadn’t reduced the principal amount early on.

Freed-up funds

Owning your own home and being mortgage-free can be liberating. If you no longer make mortgage payments, the money you used to pay it off might be best used for other purposes, such as personal hobbies or investing for retirement.

The chance to leverage home equity

If you decide to pay off a large chunk of your mortgage in advance, you can use that equity to open a home equity line of credit (HELOC) or get a cash-out refinance to make some renovations to your home. While you won’t pay off your loan if you go this route, you can use some of the cash you poured into your home.

Reduce financial stress

Additionally, the psychological benefits of debt-free living are significant, as being mortgage-free can alleviate anxiety related to financial instability. The peace of mind from paying off a mortgage may provide comfort in times of uncertainty, as a paid-off home is a secure asset that creditors cannot claim.

Cons of paying off your mortgage

As with any financial decision, paying off your mortgage early has a few disadvantages worth considering.

Possible depletion of your savings

While using your savings to pay down a huge chunk (or all) of your loan may seem like a good idea, it can be risky to pour all of your money into an investment, as this can deplete the amount of funds readily available in an emergency.

Limited investment opportunities

Paying off a mortgage early may limit investment opportunities, such as contributing to a retirement fund or earning higher returns in the stock market.

A lack of tax deductions

If you pay off your mortgage early, you lose a potential tax deduction on mortgage interest payments. This write-off, which only applies to taxpayers who itemize deductions, can increase your refund and lower your taxable income. However, it only applies if you still have a mortgage.

The potential for prepayment penalties

Depending on your lender, you may incur a prepayment penalty for paying off a mortgage too quickly. If you pay off a mortgage within the first few years of the loan, lenders will penalize you based on the outstanding principal balance. Rocket Mortgage® does not have prepayment penalties.

Pros and cons of investing first

While paying off a mortgage early can offer benefits to homeowners and lift the burden of repaying a large debt, investing extra cash in retirement funds or other investments, such as stocks, might be wiser.

Starting early with investments can maximize growth potential as returns compound over time. Historically, the S&P 500 has averaged a 9.9% annual return (1965 – 2022), and a well-diversified portfolio of stocks and bonds typically delivers long-term returns of 7% to 8%, often surpassing mortgage interest rates. For homeowners with low mortgage rates, investing extra funds in higher-yield, low-risk options may offer greater financial benefits than paying off the mortgage early.

Pros of investing your money

Before deciding to pay off your mortgage, it is important to consider the benefits of investing your money in the stock market.

A higher rate of return

Since it’s inherently riskier, investing in the stock market or something comparable allows you to earn more money than you’d save by paying off your mortgage early due to the compounding interest. Compound interest occurs when the interest you earn generates additional interest. For example, if you invest $1,000 and it earns $50 in interest, the next round calculates at $1,050. Over time, earning interest on interest can significantly amplify your investment returns.

Better asset liquidity

As for liquidity, stocks are superior to mortgages. If you need cash, selling stocks or similar investments and using that money will be much easier than selling your home or attempting a cash-out refinance.

The potential for an employer match

Employers may offer matching contributions when you invest in a retirement account, either matching a percentage of your contributions or even matching them dollar for dollar. The more you invest, the greater your potential gain, making this a valuable opportunity for gains in your retirement fund, 401 (k), or IRA if your employer participates.

Cons of investing your money

It is now time to consider the disadvantages of investing first rather than paying off your mortgage.

Riskier Investments

Investing carries more risk than paying off a mortgage. While average investment returns often surpass mortgage interest, you can lose your invested money. While investment returns can potentially exceed the savings from paying off your mortgage, there is no guarantee. Putting all your money into an investment and seeing its value decline can disappoint and even stunt your financial progress.

Ongoing debt

If you’re allocating all your funds to a retirement account or other investments, you won’t make much progress on any debts – whether they be student loans or your mortgage. While it is possible to invest to save enough to take care of these debts eventually, it might be smarter to pay them off before doing anything else since credit card debt often carries high interest rates.

Choosing to do both: pay off your mortgage and invest

It may be possible to pay your mortgage and invest simultaneously – and people do. While choosing to do both at once limits the amount you can put in your home or your investments, you can make incremental progress toward each goal as a compromise.

Consider refinancing

If you are still eager to pay off your mortgage quickly, you might consider refinancing to a shorter-term loan with a potentially lower interest rate. While your payments will be higher, you may be able to invest still while saving money on mortgage interest and building significant equity in your home.

Other considerations

If you have an influx of cash and it does not make sense to put it entirely into your mortgage or investments, these options may be worth considering:

• Building an emergency fund: To avoid or reduce the potential for a financial struggle in the event of an unexpected circumstance, such as car repairs or job loss, you could store your extra cash in an “emergency fund.”
• Paying off other debts: You could also put your extra money toward other debts, such as student loans or credit card debt. Paying a mortgage on top of numerous other debts can become overwhelming, so it is always a good idea to get those lingering debts paid off first.

The bottom line: Whether to pay off a mortgage or invest is up to you

Whether to pay off your mortgage or invest is a personal decision. Both options — investing in a stock portfolio or paying off a mortgage early — can provide financial benefits, such as savings and returns on investment. However, everyone’s financial situation is unique, so it is important to evaluate which choice is right for you carefully. Consulting a financial advisor can help you create a solid plan. Consider your finances, stability, life stage, current interest rates, risk tolerance and investment knowledge before deciding.

Remember, paying down your mortgage and investing simultaneously is possible – particularly if you can refinance to a shorter-term loan. If that possibility interests you, start the refinance process with Rocket Mortgage today.