Pay Off Mortgage Faster – or Invest?

Risk, and not just interest rates, should inform your decision.

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The stock market might be behaving badly, but that's not a reason to leave stocks out of your long-term financial planning right now. In fact, with the market near recent lows, you may be more interested in considering one of the most common financial conundrums for homeowners: Is it better to use your excess cash each month to pay off your mortgage faster or to invest?

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If this question piques your interest, congratulations for having excess cash. Not many families in the United States are as lucky as you, particularly with so many currently unemployed. Assume you have this surplus even after saving for retirement and other long-term goals and you are comfortable with your emergency fund. There are advantages to using this additional cash flow to accelerate your mortgage payments, but in some circumstances, investing the money would be a better choice.

Check with your lender to ensure you won't be penalized for paying more than the bank expects. If there is no extra fee, doubling your monthly payment from the beginning of your mortgage could reduce the total interest you pay to the lender by tens of thousands of dollars. Eliminating that interest is similar to receiving a guaranteed return equal to your mortgage interest rate.

It's not uncommon to compare this interest rate, currently averaging around 5 percent, with the average long-term return for the stock market, about 8 percent. One method for deciding whether to prepay your mortgage depends on which interest rate is higher; if your mortgage rate is lower than the expected stock market return, you should invest as much as possible and take the slow route to paying off your mortgage.

This doesn't take risk into account, however. While prepaying your mortgage is a guaranteed increase in your net worth, there are no such guarantees when investing in the stock market. Building equity in your house, which you can accomplish faster by accelerating your mortgage payments, is a relatively safe storage of your wealth when compared to a stock market index fund or a small selection of stocks.

In addition to this risk, the stock market is volatile. Your mortgage interest rate won't change year after year unless you refinance; your stock market investment may lose value for several years and take the rest of the decade to recover. Worse, the stock market may decline in the final years as you begin to need those funds to replace your income and never recover.

Also consider your expected retirement date. If you follow a typical career path, you will likely have less income to spend in retirement. By eliminating your mortgage quicker, you pay your mortgage down when you can better afford the payments, releasing yourself from anxiety, stress, and house payments when your income shrinks in retirement.

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Other factors contribute to this decision. If you don't plan on staying in your current house and expect to sell within a few years, there may be no need to speed up your mortgage payments. If you decide to invest your excess cash because of the anticipated financial benefits, you must commit to investing. I've heard from many readers who choose not to send the bank their extra money each month with the intent to invest, but other expenses inevitably arise. Whether it’s lack of discipline or necessity, the misdirected cash prevents these families from seeing the benefit of a stock market that generally, over the long term, increases at a rate higher than most mortgages.

Whether to pay your mortgage off early or to use your excess cash to invest is a personal decision. While the numbers may help you decide, you can't make the choice without considering your needs beyond having the highest net worth possible at the end of the day and your ability to stick to the plan.

Flexo encourages discussions about money and consumer issues at Consumerism Commentary, a premier blog focused on personal finance.