Should I Pay Off My Mortgage Early Or Invest?

This article will present an alternative approach that incorporates investing.

Those who argue against paying off a mortgage early make a mathematical argument in favor of investing those additional dollars with the expectation of making a spread between the higher expected return of the investment versus the interest rate on the mortgage. This is an argument in favor of using leverage to build more wealth. An individual could do both by investing additional dollars in order to create an account that eventually becomes large enough to pay off the remaining mortgage balance.

Assumptions

• 30 Year $500,000 fixed rate mortgage at 3% with a monthly payment of $2,108
• $1,000/month of additional dollars available to either invest or apply towards principal
• A Global Equity allocation as the assumed investment portfolio, 50th percentile Monte Carlo simulation using historical returns from 1990-2020
• The impact of taxes are ignored for the sake of simplicity

Scenario 1: Pay $1,000/month additional principal towards mortgage

If an individual were to make an additional $1,000/month payment towards the principal balance of the mortgage, a 30 year payment plan would be reduced to just over 17 years. For the remainder of the 30 year period, an individual could now invest $3,108 per month. The expected value of this portfolio would be $1,051,000 at the end of the original 30 year period.

Scenario 2: Invest $1,000/month and pay off the mortgage when the portfolio value is equal to the outstanding principal.

Using the same investment assumptions, this would be expected to occur by the end of year 13, cutting 4 years off the length of time it would take to pay off the mortgage. If we look at the 25th percentile of all simulated outcomes, it would take 15 years. If the individual now increased the investment to $3,108/month and was able to do so for 17 years instead of 13 years as in scenario 1, the expected value of this portfolio would be $1,745,882. Using the “4% rule”, a $694,882 increase in wealth could provide $2,316 of additional monthly retirement income.

Scenario 3: Invest $1,000/month for the full 30-year period and not pay off the mortgage early.

Just to show it, I’ve also calculated the expected value after 30 years if the individual decided against paying off the mortgage early and instead invested the $1,000/month for the full term. At the end of 30 years, the individual would have the same paid for home and a $2,429,008 portfolio value. There clearly is an expected (although certainly not guaranteed) opportunity cost for paying off a mortgage early that should be weighed against the marginal utility of wealth that would be associated with a $1,378,008 greater portfolio value that could generate $4,593 of additional monthly retirement income.

Summary

The question of “should I pay off my mortgage early or invest?” is one of the most commonly asked personal finance questions. There is no obvious answer, as it depends on many variables that are specific to each individual’s financial situation and risk tolerance. Due to the complexity of the decision, you may consider paying for an hour of professional advice. In general, I recommend that individuals first focus on eliminating high interest consumer debt and contributing to retirement accounts such as employer 401k plans and Roth IRA’s before tackling the decision on how to best handle their mortgage.

Once that is accomplished, lump sum principal payments should first come from cash and fixed income as paying off a mortgage is similar to investing in bonds. Then the next decision will revolve around what you value most. Is it the financial peace of being debt free and having a paid for home at a young(er) age, or the utility value of greater expected wealth and retirement income later? If you don’t lean strongly in either direction, a sensible decision may be to go with a balanced approach similar to scenario 2 that applies to your situation.

Jesse Blom is a licensed investment advisor and Vice President of Lorintine Capital, LP. He provides investment advice to clients all over the United States and around the world. Jesse has been in financial services since 2008 and is a CERTIFIED FINANCIAL PLANNER™ professional. Working with a CFP® professional represents the highest standard of financial planning advice. Jesse has a Bachelor of Science in Finance from Oral Roberts University.