Let’s play out a hypothetical scenario here about our friends, Jane and John. As they start their lives together, they’re planning on moving into a new house. Together, they’re a high-income earning family and live below their means, which means they’ve got some extra money each month. They’re just getting started to really get a strong hold on their finances. Currently John is maxing out his 401(k) and HSA at work and also contributes to an IRA up to the max. Jane contributes the maximum for her 403(b) plan and also has an IRA which is fully-funded. By most measures, they’re on the right track.
Because they’re not overly flashy and have curbed lifestyle inflation, they have an extra $500 each month that they can comfortably do something with. This is money after basic expenses and some other things travel and general entertainment. They could probably live a bit more in the ‘now’, but they’re comfortable with their lifestyle and would rather put the money to work in some way instead of getting used to spending more.
John and Jane’s Goals
John wants to retire early and so he’s debating how to maximize his ability to do so. On one hand he really doesn’t want to retire with a mortgage. If they don’t have a mortgage, they figure they can keep their spending to about $40,000 a year. John’s figured out if they put the full $500/mo at his mortgage, he can shave off 11 years. Doing so would mean that there isn’t a lot of wiggle room in their budget. As their income grows they can afford some more things, but they wouldn’t have much ability to invest in after-tax accounts. It’s comfortable, but a bit prohibitive.
Jane is less concerned with early retirement, and just wants to make sure they’ve got a sufficient nest egg saved up to retire. They both want to travel once they retire, and making sure they retire with more than enough is important to Jane. She sees the mortgage as a necessarily evil, and prefers to watch her money grow instead of being tied up in the house. She hates the mortgage payment as well, though, and would gladly see it gone…but not at the expense of their retirement.
Really, Jane and John are in a great situation, but they can’t agree upon how to proceed. What should they do?
Pay Down Mortgage or Invest?
What should Jane and John do with their money? Should they pay off the mortgage like John wants? Is investing, like Jane wants, a better alternative? They decide to reach out to some of their financially savvy friends and see what they would do. They get conflicting messages. Tons of them. “The market on average will yield returns greater than the interest rate on the mortgage! You should obviously invest!!” “Mortgage payments are a huge amount of your budget. The less you need to spend, the less you need in your nest egg. Pay that mortgage down!” “Equity in a house isn’t very liquid, paying the mortgage early just ties up your cash.” “Interest is tax deductible, milk that for all you can!” “The market is unpredictable, but the mortgage is guaranteed return!”
Math Doesn’t Matter
Here’s the truth of the situation. The math really doesn’t matter. No no, I’m not dispelling math – but the decision to pay down your mortgage or invest the money clearly isn’t a mathematical one for them. There are many benefits to having a mortgage (over renting) that people will cite. It’s true that the interest is tax deductible. Leverage – the ability to use debt to get something you wouldn’t otherwise be able to afford – is a great tool that makes home ownership possible for many people.
Since mortgage interest rates are relatively low, it’s true that historically the stock market has outperformed mortgage interest rates. It’s not a rule though, and the stock market could go down. Still, over the long haul, clearly the math points to the advantages of holding onto the mortgage and investing the difference. But there’s a kicker if you generalize this advice across the board…
Most People Suck at Investing
The average person is a horrible investor. Sure you might have an extra $500 or $1000 in your budget, but relatively few people actually invest it on a regular basis. Most of the time this money slips through the cracks somewhere. Even if contributions are automated, it’s possible to stop investing, or stop paying the mortgage off more quickly, when something bad happens. It’s not reasonable to expect the average person would be able to follow through on either of these plans with 100% consistency for 20-30 years. Life happens, things change.
Besides flat out abandoning plans, lots of people don’t even know where to start with investing in taxable accounts. Folks will choose individual stocks and gamble. The number of times I talked with an old coworker about how many thousands of dollars he lost (or gained) in a single day off penny stocks is mind-boggling. Others will get scared on a downturn and cash out, either potentially losing money, or just in general limiting their gains. You might not do that – after all, you’re awesome and reading a financial blog that most folks wouldn’t. But still.
Don’t Piss It Away
This is the main point I’m trying to make. Math may suggest that in the past it makes more sense to invest instead of pay off a mortgage. Having a smaller monthly income requirement frees up a lot of options. If you don’t need to pay a mortgage, you can effectively free up that much in your salary requirements. Perhaps you could take part-time work, or one spouse could stop working and focus on a side hustle. You could invest and pay the mortgage down at a slightly lower rate, too. That’s a bit of a middle ground that gives some degree of flexibility and keeps some money a bit more liquid.
Just don’t piss that extra money away. Don’t spend it on stupid stuff like new cars and gadgets that you don’t need. If you have to ask this question, the truth is, you’re in an amazing position to have the flexibility, so be thankful you can do whatever you want! There’s nothing wrong with either approach!!
At the end of the day, whenever people ask this question I’ve started to just say “Do what feels best“. We are all different, have different goals, live different lives with different struggles and things that impact our decisions. Whatever feels like the right decision between investing and paying down the mortgage probably is the right decision for you.
You can ask others for advice and understand the pros and cons to both. Don’t let someone make you feel bad for the decision you’ve made either way. They can’t possibly understand the full depth and breadth of decisions and variables that factored into your choice.
If you are paying off your mortgage early AND/OR investing, know this: you’re doing it right.
Are you a big proponent of either paying off the mortgage early or investing? Which one, and why??