I can completely pay off my mortgage early. Should I pay it off or invest?
My mortgage is 3.5% fixed rate. I have enough money to pay off the remaining balance, and still have enough left over for an emergency fund.
My investments have historically made more than 3.5% per year, and I’m fairly confident that I can make an average rate of 3.5% or more going forward. (Not guaranteed, of course, because there is still risk).
Does it make sense to forgo paying off my mortgage early and just invest that money? Other than investment risk/returns, what other factors should I consider?
The main reasons not to pay off your mortgage early are:
You shop around various banks and discover that your current mortgage rate is fixed at a lower percent than most other banks are offering on new mortgages today.
Everybody seems worried about or is experiencing inflation.
You are not restricted in what you can invest in, and your investments are getting a better return than your mortgage rate.
You are uncertain about your job security.
You wouldn’t have much cash left after paying down the mortgage early.
You get insurance that would be difficult to obtain without a mortgage (coastal hurricane/flood insurance)
The main reasons to pay off your mortgage early are:
You have restrictions on what you can invest in either legally or contractually, an you don’t have any other higher-rate debt.
Mortgage rates are dropping or you are able to get a new mortgage at a lower rate (refinance)
You have a variable-rate loan and don’t want the stress of it hanging over your head.
You think you might be sued. They can’t come after your home if you have a homestead exemption in some states, but they can come after your cash.
Welcome to Money.SE. Please forgive what might sound like a cliche, “How well do you sleep at night?” I mean, specific to the mortgage. There are those who are in a group who consider debt, at any rate, to be inherently bad, and would not take on a 2% mortgage even if a different bank were offering 4% CDs. You just need to understand the risk.
Your mortgage cost after taxes may be 2.625% (if you are in the 25% bracket) therefore, your break even is 3.09% for long term investments. The recent “lost decade” had a return of -9.5% for the full 10 year period. This is just about the worst decade in modern history. The average 10 year return is a cumulative 183% gain, with a standard deviation of 138%. If a perfect bell curve, this means that 1 10 year in 6 will give you a return under 45%. In fact, of the last 100 10 year periods, 15 had returns less than 45%, and just 8 were less than 30%, right in line with the bell curve stats.
We always need to say “past performance is no guarantee of future results,” yet, when it comes to the market (I use the S&P for my numbers, by the way) we do have history to give us an idea of the kind of volatility we might see over the years. In my opinion, your approach is sound, and your returns very skewed to the positive, the median 10 year return being 138%, vs your cost of money of 40% or so for a decade.
It’s pretty easy to pull S&P data into a spreadsheet and analyze as you wish.
If your house was paid off, would you be comfortable borrowing from the equity to invest?
This is essentially the same question.
Also, why not ask the opposite? How much more should you be borrowing (at a similar rate) for investments?
Your answer to both questions will be clues to how you view the risk/reward of borrowing against your house in order to invest.
My personal preference is not to invest with borrowed money. There may be a few percent of potential returns I am missing out on. That percent return has to be analyzed in the context of a full financial plan and future goals.
I would recommend not paying it off early for 2 key reasons:
If you are a resident of the U.S. you get tax deductibility of mortgage interest, which as pointed out in previous posts, reduces the effective interest rate on your mortgage, never in your life will you ever be allowed to obtain such high leverage at such a low rates.
You can probably get higher returns with not much risk. @JoeTaxpayer mentioned various statistics regarding returns when investing in equities. Even though they are a decent bet over the long term, you can get an even better risk reward tradeoff by considering municipal bonds. If you are in the U.S. and invest in the municipal bonds of your state, the interest income will be both federal and state tax-free.
In other words, if you were making 3.5% investing in equities, your after tax returns would be significantly less depending on your tax bracket whereas investment-grade municipal bond ETFs will yield probably the same or higher and have no tax. They are also significantly less volatile. Even though they have default risk, the risk is small since most of these bonds are backed by future tax obligations, or other income streams derived from hard assets such as tolls or property. Furthermore, an ETF will have a portfolio of these bonds which will also dampen the impact of any individual defaults.
In essence, you are getting paid this spread for simply having access to credit, take advantage of it while you can.
Advantages of paying off debt:
Potential advantage of remaining in debt: