Should You Pay Off Your Mortgage or Invest?

Posted April 29 2015
by PenFed Team
Plastic houses and U.S. coins

It’s hard not to feel a pang of jealousy when a friend or family member pays off their mortgage early. Debt-free living while owning your home free and clear—what a fantastic feeling that must be. Meanwhile, you’ve been chugging along at your investments, and while you believe your strategy is sound, you sometimes wonder if you should you have chosen to knock out your mortgage first.

The truth about choosing between paying off your mortgage or investing your money is that personal choice can play as crucial a role as many financial factors. There are plenty of hard and fast rules about financial goals you should take care of before paying off your mortgage, but once you’ve taken care of those factors, you’ll find the payoff versus investment choice isn’t as clear.

Before considering a payoff

You’re almost certainly getting ahead of yourself if you’re considering investing or paying off your mortgage before you’ve taken care of these crucial financial goals:

  • Pay off high-interest debt. Even the most successful investors aren’t likely to earn more from their investments than they’d pay out on high-interest credit card and other debt. It makes no sense to try to save money while interest is eating you alive. Pay off your debts.
  • Build your emergency fund. Everyone needs a good three to six months’ worth of income in the bank to take care of the unexpected. Make sure your rainy day fund is solid before beginning any investment or payoff plan.
  • Make the maximum contribution every year to any 401(k) or other retirement plan for which your employer offers to make matching contributions. You get a secure, easy way to save money, and your employer gives you extra money on top of that—that’s what they call free money. Don’t pass that up.
  • Make the maximum annual contributions to other tax-deferred or tax-free retirement savings plans and IRAs. Here’s a chance to lower your yearly tax obligation; take it.
  • If you’re planning to help pay for college for your children, find more tax-deferred savings in college savings plans like a 529 college account or a Coverdell IRA.

More considerations

Once you’ve taken care of the financial basics listed above, you may be ready to consider investing or paying off your mortgage. First, though, you need to know how much your mortgage interest is actually costing you. Remember that if you’re deducting your mortgage interest on your income taxes, you’re effectively lowering your mortgage rate. If you’re only paying an effective 3% to 5% on your mortgage, it will probably be quite feasible to out-earn that through smart investing.

If it makes more sense for you to claim the standard deduction on your income tax, though, you won’t be deducting your mortgage interest and it might not be as easy to outpace mortgage interest paid.

Would paying off your home mean pulling money out of your savings? Don’t sacrifice your security just to get rid of that monthly payment. You never know what might happen in the years ahead, and you certainly don’t want to sacrifice the headway and gains your retirement savings are already earning.

If you’re already set with enough money to make a sizeable investment, you could generate enough returns to cover your monthly mortgage payment. This smart strategy leaves your savings nest egg intact as investment principal while still painlessly covering your mortgage payments.

Making the right choice

Financially speaking, the right choice between investing or paying off your mortgage is a matter of which provides the highest return after taxes. In general, investments almost certainly outperform mortgage interest over the long haul—but investing does carry an unavoidable element of risk, and paying off your mortgage represents a sure thing with no risk attached.

Getting rid of those pesky monthly mortgage payments increases your financial freedom and gives you more control over your monthly cash flow. And you may find that you simply cannot put a price on the emotional benefits of owning your home debt-free. The peace of mind that comes with knowing the financial ups and downs of life will not affect your home can be priceless.

The right answer for most people is a financially savvy decision that factors in your personal feelings about debt, ownership, cash flow, and risk. PenFed can help you get started plotting your course no matter which route you choose: investing for the future with PenFedInvest, or refinancing your mortgage, or paying it off ahead of schedule.

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