Making the Most of Discretionary Income: Mortgage Reduction or Investing?

Some people are uncomfortable with outstanding debt. Making additional payments toward the principal on your mortgage allows you to build equity in your home more quickly while reducing the total amount you will pay in interest over the course of your mortgage. If you are approaching the end of your mortgage term, it can be tempting to pay it off as quickly as possible so you no longer have to budget for mortgage payments and can enjoy being completely debt- free. In contrast, if you still have a long way to go in paying off your mortgage, building equity in your home may allow you to qualify for a lower interest rate when you refinance, saving you even more in interest. In either case, there is merit to considering an accelerated debt payoff. And because stock market returns fluctuate from year to year, weighing your mortgage interest against historical returns can be challenging. This is especially true for those who are particularly debt- averse or who have a low risk tolerance.

Nonetheless, from a purely financial perspective, investing typically enables individuals to increase their net worth more in the long run than paying off their mortgage early would allow. The stock market has historically returned approximately 10% on average each year, whereas fixed mortgage interest rates have generally been lower because of the prolonged low interest rate environment since 2009. Low mortgage interest rates mean that investors have a lot more to gain by making consistent mortgage payments and investing discretionary income. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal.

Additionally, although home values tend to appreciate over time, a family’s primary residence is not a liquid, income-producing asset in the way an investment portfolio can be. In the event of a financial crisis, you will not be able to access the money you have already paid toward your mortgage without taking out additional debt, which, in many ways, defeats the purpose of paying down the debt in the first place. Although reducing how much you pay in interest will free up more of your income over time, it will not provide compounding returns in the decades to come. By choosing to invest now, you may be able to accumulate a portfolio large enough to pay off your mortgage early in a lump sum and still have money left over for retirement.