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I’ve Got Some Cash – Is It Better to Invest the Extra Cash and Take Out a Larger Mortgage, or Have the Smallest Mortgage Possible to Reduce Debt?

You’ve worked hard to build a sizeable chunk of cash and want to put it to good use. But how do you know if it’s better to pay down a mortgage or invest? There are many schools of thought on this topic. We’ll lay out the facts and other considerations to take into account to help you decide the best option for you.

Investing or paying off a mortgage: The math

The cut and dried approach is to run the numbers. In this case, we’ll compare potential investment earnings to the interest saved on a mortgage if you start with a higher down payment.

Let’s say you’re planning to buy a $350,000 home and you have $75,000 available for a down payment or investing.

Option A: High down payment

In this scenario, you choose to put all $75,000 down. This example secures a 6 percent interest rate, making your monthly payments of principal and interest (P&I) $1,649. After 30 years of payments, you’ll pay $318,555 in interest.

Option B: Low down payment, invest extra cash

To the contrary, you put the lowest amount down your lender will allow on a conventional loan – $12,250. That causes the interest rate to rise to 6.5 percent, making your total interest paid after 30 years $429,902. Your remaining cash of $62,750 is invested in the stock market with an average annual return rate of 8 percent. This is a conservative estimate, with the S&P 500’s average annualized rate of return being just shy of 12 percent since its tracking began in 1926.

*Actual payment would include private mortgage insurance.

Comparing the numbers

By putting more money down in Option A, you save $111,347 in interest payments ($429,902 - $318,555). That’s a lot! But your investments in Option B could earn $568,682, putting you ahead by a grand total of $457,335 ($568,682 - $111,347).

So even by paying more than $100,000 in additional interest, you come out ahead by over $450,000. Looking at the numbers alone, Option B is the clear winner.

Of course, it’s important to note that investing comes with risk. This example was based on average market returns and a long-term strategy, but there’s no guarantee that you’ll have gains or avoid losses.

Mortgage vs. investment: Other considerations

If the answer were truly black and white, there wouldn’t be so many differing opinions on this topic. Here are some additional things you can think about to help weigh your options.

What is your mortgage interest rate?

Your interest rate is a key player in this equation. The lower your rate, the less you’ll end up paying for your mortgage on top of the loan principal. That makes focusing on investing an attractive choice. But if your rate is higher, closing the gap between what you can potentially earn in investments, you may choose to make paying off your mortgage a priority.

• Key takeaway: The higher your interest rate, the harder it is for investments to outperform the interest savings on a mortgage.

How comfortable are you with risk?

As we mentioned, investing is risky. The fluctuating market makes it hard to predict whether your investments will come out ahead. And even if they do, all the ups and downs can cause emotional distress along the way. Conversely, paying down your mortgage is a safe and guaranteed way to build wealth.

• Key takeaway: Investing a down payment instead of using it toward a mortgage is riskier. Even if a higher return is estimated, it’s not guaranteed.

How far away are you from retirement?

There are pros and cons of paying off a mortgage after retirement. An argument against paying off your mortgage is that investments are more liquid, making it easier to access should you need the funds. Owning your home is a big asset, but it may not be as easy to access its equity. On the other hand, not having a mortgage payment can reduce monthly expenses – a goal for many retirees. And again, those funds are guaranteed to be there when you need them.

• Key takeaway: The decision to pay down your mortgage or invest is especially important if retirement is drawing near.

Do you plan to use your home’s equity?

Speaking of equity, do you foresee using it to your advantage in the future? From home improvement projects to securing a better interest rate during a refinance, increasing your equity can offer many benefits.

• Key takeaway: A higher down payment builds home equity faster.

How long do you plan to stay in your home?

Is this a starter home or your forever home? If you plan to move in the next few years, building equity may not be a priority. You may choose to focus on investing rather than paying down the mortgage. Just keep in mind you’ll likely need to access those funds for your next down payment since it won’t come from equity.

• Key takeaway: Paying down a mortgage may not be a priority if you plan to sell your property in the near future.

Do you have other savings?

A common rule of thumb is to keep savings on hand for three to six months’ worth of expenses. While paying off your home and growing a nest egg are worthwhile goals, they shouldn’t come at the expense of not being able to pay the repair bill if your car suddenly breaks down.

• Key takeaway: Extra mortgage payments and investments shouldn’t come at the cost of today’s needs.

Do you have other debt?

We’ve been answering an either-or question of invest vs. mortgage, but those aren’t the only options. Another question could be: Should I pay off my car or invest Car payments, credit cards, and personal loans come with differing interest rates. Generally, the higher the rate, the more important it is to get rid of it sooner.

• Key takeaway: Investing doesn’t erase debts. Especially if interest rates are high, it’s important to pay them off, too.

How important is it for you to be debt free?

Financial expert Dave Ramsey says that personal finance is 20 percent head knowledge and 80 percent behavior. And often, money behaviors are driven by psychology. So if a paid-for home eases an emotional burden, you may choose to make paying off your mortgage a priority.

• Key takeaway: The numbers aren’t everything. Understand what financial decisions motivate you and will drive behaviors that last.

A happy medium

Truth is, most people find success – and peace – somewhere in between these extremes. You’ve heard the warnings about putting all your eggs in one basket. In deciding if it’s better to invest or pay off your mortgage, consider diversifying to find a happy medium.

That could look like putting down a healthy down payment that avoids private mortgage insurance, keeping some savings for an emergency fund, and investing what’s left of your cash. As your income grows, you can pay extra on the mortgage or add to your investments (or both), depending on what makes sense for you at the time. You may find that your priorities shift over time with both personal and external factors. No matter what, you can rest easy knowing you’ve built a strong foundation.