Should I stop investing in US stocks and pay down my mortgage ASAP? Here’s the math
If you have some extra money to set aside each month, you might wonder if you’re better off investing it or using it to pay down your mortgage faster, especially if mortgage rates are ticking up and you have a new or variable rate mortgage.
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Keep in mind that experts recommend you build an emergency fund worth three to six months of expenses before you put money towards paying off debt or investing. Once you have this financial cushion, you can start to consider what would be the most effective way to use your money.
In order to make an informed decision, you need to calculate the opportunity cost. This is the potential returns or savings you would give up.
Say you’ve already locked in a low mortgage rate and have a balanced, diversified portfolio, it may make more sense to invest your extra cash. But if your mortgage rate is higher than the return you can get on your investments, then you might want to focus on your mortgage first.
But it's not that simple. You’ll need to consider other factors, like your life stage and risk tolerance, whether you may need access to cash in the near future (paying down your mortgage early means lower liquidity), and if getting out of debt faster will have psychological benefits (after all, some people sleep better without a 30-year debt weighing them down).
There’s no “right” answer since the decision will depend on your own unique circumstances.
Comparing returns
Crunching the numbers could help you make an informed decision. Let’s say you have a 30-year fixed-rate mortgage of $250,000. As of April 4, the average rate on a 30-year fixed-rate mortgage in the U.S. per Freddie Mac was 6.82%. Using a mortgage calculator, we see that your monthly payment will be $1,633.14 and you’ll pay a total of $337,932 in interest.
If you’re able to come up with an extra $500 per month, should you invest it or use it to pay down your mortgage faster?
If you pay an extra $500 per month on your mortgage, you’ll reduce the time it takes to pay it off by 13 years and 10 months. And this translates to savings of $175,082 in interest.
The average annualized return on the S&P 500 from 1957 to the end of 2023 was 10.26%. Assuming this return, if you were to invest $500 at the beginning of each month for 16 years (for comparison sake, this is approximately the amount of time it would take to pay off your mortgage in the above example), you’ll end up with $222,962.61.
With these assumptions, investing your money would net you around 47,000 more, in comparison to paying off your mortgage faster. Of course, your portfolio may be less aggressive or your mortgage rate may be higher, so it’s worth doing your own calculations (there are many online calculators that can help you do the math).
Past performance is no guarantee of future results
While comparing your options, remember the stock market can be unpredictable and volatile, and there’s no guarantee that you will earn the historical average return.
It’s always safer to compare buying assets with guaranteed returns, like U.S. Treasury Securities, to paying off your mortgage early.
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Your risk tolerance is higher if you have a long investment horizon. For example, if you’re in your 20s, you might want to put money in your 401(k) so you can benefit from compound interest while simultaneously paying down debt. In case of downturns, you still have time to wait for the market to recover and your long-term returns to exceed your mortgage rate. If you’re closer to retirement, a more conservative approach may be preferred.
Other considerations
If you have an employer-sponsored retirement account and your employer will match your contributions, then it may make sense to consider this option — it’s like getting free money, and that free money also earns compound interest over time. Plus, maxing out your tax-advantaged retirement accounts can provide certain tax benefits.
By paying off your mortgage early, you could save a boatload in interest payments, while building equity in your home faster. This is important if you’re paying for private mortgage insurance until you build enough equity in your home.
Also consider that you could be penalized for paying off your mortgage faster. Some lenders will ding you with a prepayment penalty — and those are dollars you could be investing elsewhere. It may be worth a chat with your financial advisor about which option will work best for you.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
