Should You Pay Off Your Mortgage or Invest?

Here’s how to decide what to do with a windfall of cash.

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Paying off your mortgage lowers your monthly expenses and gives you the guaranteed return of paying down debt. However, the potential rewards could be higher if you invest your cash, depending on how you allocate your money.

[See 10 Places to Retire on Social Security Alone.]

Consider a 65-year-old women with three properties interested in retiring in 5 years. She just sold one property and has a windfall of cash. Should she pay off her other properties or invest the money in the stock market or a new property? Here are her options for the proceeds of the property sale.

Buy more property. The most entrepreneurial move would be to buy more real estate to take advantage of current low prices and interest rates. But this aggressive tactic would expose her to the risks of being a landlord even more than she already is. Also, if a tenant moves out or fails to pay rent, she might find herself in a negative cash flow position.

[See 10 Ways the Recession Has Changed Retirement.]

Invest in the stock market. The next alternative is to take the proceeds from the sale and invest it in growth and income mutual funds. This would help her diversify her investments and reduce the risk of being a landlord. The downside is that the market is and will always be a volatile place over the short-term.

Purchase an annuity. Purchasing an annuity contract would give her a predictable retirement income stream. However, the tax benefits are greatest for those in a high tax bracket. She also might not want to lock her money up at the low rates that annuities currently offer.

[See 10 Things You Should Know About Your IRA.]

Pay off your mortgage. The least risky option is to use the proceeds of the sale to pay off the mortgage on her current property. Any left over funds could then be invested in the stock market. This alternative would allow her to diminish her role as a landlord. It also increases her monthly income and makes it easier to retire sooner. And by taking some money and investing it in the market, it helps diversify her holdings. While this is the least risky alternative, it also has the least potential return. If real estate does really well over the next 5 years, she would be far better off by buying more real estate.

Neal Frankle is a certified financial planner and runs Wealth Pilgrim, a personal finance blog that helps people make smart decisions about their money. As a start, he suggests that you strive to understand your credit score range.