Should You Pay Down the Mortgage Early or Invest Instead?

Whether you should pay down your mortgage faster, or invest instead, is one of the longest-running debates in personal finance. What should you do with any extra money that you might have- pay off your mortgage, or invest? There are certainly advantages and disadvantages to both sides.

Sure, you can be completely analytical and run the numbers to get an estimate of which is better for you in the long term and decided that way, but there is more to it than that.

To help you decide which is better, to pay your mortgage, or to invest, here is a list of several advantages to paying off your mortgage, followed by several advantages to investing instead. Ultimately the choice is up to you.

Pay off your Mortgage Early Instead of Investing

When you finally get your deposit sorted and get into a home it’s easy to want to pay off your mortgage as fast as you can. And there are many benefits in paying down your mortgage fast.

Forced Savings

Paying the mortgage off faster is also a forced savings scheme. If you have opted into paying extra, and now the bank will hold you accountable. You have to make those payments. Definitely extra motivation to keep the payments up to date.

For certain people, this can be a good method to force you to save extra. Decide what payment amount above the minimum is appropriate for your budget and away you go. Unlike investing- the bank will ensure that you pay what you said you would.

Guaranteed Return on Your Money

Paying your mortgage gives you a guaranteed return on your money. Your return on investment is equivalent to your mortgage rate plus tax. Assuming a 28% PIE tax rate on your investments, and a 4% mortgage, your extra contributions will be effectively returning you 5.5% per year on interest savings.

The share market, on the other hand, is not guaranteed. The share market can go up and down like a roller coaster in the short term- but upwards in the long term. Because of the uncertain return in investing outside your mortgage, it might be comforting to know that you will get a certain guaranteed return from paying down your mortgage faster rather than investing.

Improve Cashflow in the Long Term

When you reach the goal of paying off your entire mortgage you will have freed up some extra cash at every paycheck. This can be a blessing and a curse a the same time.

Having no mortgage payments you have extra security. Your regular income now only needs to cover your living costs (and any other debt payments). This means that you either have a large chunk of extra cash you get to keep, or you can afford to decrease the amount of work you do.

Both are great- you will either have extra money or more time. The problem is that with extra cash comes lifestyle creep.

Save on Interest

It’s quite common to pay just as much in interest as you do in principle. That is for a 30-year term the cost of your house is twice what you agreed to pay the previous owner. That is the miracle of compound interest working against you.

So it makes sense to pay off your mortgage off as soon as you can. You can save tens of thousands and even hundreds of thousands in some case.

A $450,000 mortgage paid over 30 years costs you $370,560 in interest with a weekly repayment of $526. Increase that payment by $100 a week and you will cut the term down to 21.6 years, and it will cost you $254,100 in interest- a saving of $116,460!!

Own Your Own Home

Paying down your mortgage faster may bring you peace of mind. Owning your home outright with no mortgage will allow you not to worry about ever being late on mortgage payments. You’ve broken the proverbial shackles that the bank has put on you.

You also get to say that you truly own your home. Many people say they own a home, just like me, but in reality, the mortgage against the house implies that you really don’t own it outright. Paying off the mortgage early will give you the security in knowing that the bank can never sell the house from under you.

You Might Not Like the Idea of Debt

Some people just don’t like debt- any debt- including a mortgage. And that is fair enough. Being in debt implies that you are subservient to someone else. And the idea of someone else having this power over you might push you to sacrifice and reduce your spending to pay off the mortgage quickly to get back control over your life.

Invest Instead of Paying Your Mortgage Early

So maybe the reasons for paying down your mortgage faster don’t resonate with you. Well, take a read of some of the reasons why you should invest instead.

Possibility of Earning Higher Interest

There is an opportunity cost associated with paying off your mortgage faster. Every dollar you devote to paying down your mortgage is another dollar that you can’t use for any other financial goals. You have a limited amount of money, and paying more on a low-interest rate mortgage might not make financial sense. Especially if you are not in, or are not contributing to Kiwisaver.

While paying down the mortgage faster affords you a guaranteed return on investment, your return is low because mortgage rates are at an all-time low. If your mortgage rate is 4%, then your rate of return on the money you use to pay your property off earlier is about 5.5% when you consider that you pay tax your investments. Considering that the NZX50 had an averaged return of 7.8% over the last 69 years which beats your guaranteed return of 5.5%.

Diversification of your Finances

Investing increase your financial diversification. Sinking all your money into your mortgage means you are heavily invested in real estate- if you think of your home as an investment.

Having a diverse set of investments is one of the foundation of any portfolio. Diversification is simply not putting all your eggs in one basket. And the reason for this is that if you drop that basket, you break all the eggs. But if you have many baskets with one egg, and you drop that one basket, you only break one egg.

There are two main reasons you want to diversify your investments;

  1. Protecting your investment capital, and,
  2. Ensuring you are able to minimize your risk and maximize your returns

Spreading your investments over different investment vehicles outside your home makes it more likely that you won’t lose all your investments in one single market turn down- like a property crash.

Investments are more Liquide than your Home

Investments outside of real estate are liquid- meaning that at a drop of a hat, or a click of a button, you can sell your investments. You can sell all, or in most cases, you can sell part of your portfolio if you need cash quick.

Your home is not liquid- you can’t just go and sell it when you need a bit of extra cash. Nor can you sell a smaller part of it to cover expenses in the short term. And in a slow real estate market- it can take months for a house to sell.

Learn About Investing Earlier

The best time to start investing is yesterday, and the second-best time is today. The earlier you start investing the faster you will learn, and the more time your investments have to grow.

If you start investing with a small regular amount you will start to learn about investing sooner- and you can afford to make stupid mistakes. Both because you have a small amount invested, and you have time on your side.

If you start investing once you have paid the mortgage off, you don’t have the luxury of time to both learn about investing and time for your investments to compound. And you’ll likely have a larger regular amount that you want to invest with, so you can’t afford to learn by making mistakes- like me when I decided to case returns regardless of the fees.

You Will Never Truly Own Your Home

You might think that once you pay off your mortgage you are free and clear. However, even if you no longer owe the bank anything- there are still property rate that you have to pay. And on top of that, there is always ongoing maintenance expenses.

While your property rates and maintenance expenses will be much lower than your mortgage payments, you can never truly eliminate all expenses related to your home. Nor can you eliminate all the risk of losing your home.

A little-known legal clause gives local councils the right to force your banks to cover unpaid rates, normally taken out of your mortgage account – at worst this can put mortgages into default. And if your mortgage is in default for too long the bank can sale you home from under your own feet.

And if you own your home outright (if you have no mortgage) and you don’t pay your rates councils, the council has the power to go to the high court for an order to sell or lease your property to recover the rates.

Inflation Reduces your mortgage

Time will effectively make your mortgage smaller. If your mortgage was fixed for the lifetime of your loan the payments stayed the same for the entire life of your loan. You will be paying the same today as you would be paying in 30 years. The difference being that inflation reduces its value.

$1000 today is worth $1811 in 30 years time and $1000 dollars in 30 years time is worth $552 today- assuming 2% inflation. Your mortgage that cost $1000 today, will effectively cost you $552 in today’s money. Your mortgage effectively costs less over time.

On the same hand, the interest that you save from paying your mortgage earlier must also be discounted for inflation. Let’s say that you pay off your mortgage 10 years earlier, and you saved $100,000 in future interest- 20 years in the future to be exact. So your $100,000 interest savings is effectively only $67,000.

Final Words

With all that said- there is still one very important element missing from this debate. Your lifestyle and future goals. Ultimately the choice is up to you and no one can tell you which was is right for you but you.

To sum up;

Reasons for Pay Down the MortgageReasons to Invest Instead
Guaranteed ReturnPossibility to Earn a Higher Return
Against the Idea of Being in DebtDiversification
Interest SavingsLiquid Assets
Improve Cashflow Once it’s Paid oOffYou Never Truly Own a Home Anyway
Forced Saving PlanLearn About Investing
Peace of MindInflation

Now this entire debate only works if you are fortunate enough to be on the property ladder- which is becoming harder every day in New Zealand.

So do you have a reason for doing one over the other?

Let me know in the comments. Do you pay more on your mortgage? or do you invest any extra cash? Or are you still trying to get onto the property ladder?

The truth is that I use to be heavily focused on paying down the mortgage as fast as I could. I hated the idea of having a mortgage and wanted to be free. Now, I’m not as aggressive. We still pay more than the minimum and we invest the difference into other investments. Attempting to have our cake and eat it too.

I’ve come around to believe that if I pay the mortgage off faster- All I will be doing is tieing capital up into my home. And when it comes to retirement- I can’t eat my home.

Because I do both- invest and pay the mortgage above the minimum, I was asked the following question. Would I be willing to refinance my house and increase my mortgage to add to my investment account? My answer was no. Does that make me logically inconsistent? I’m doing exactly that right now- carrying extra debt so that I can invest instead.

Following the same suit- I’m not willing to liquidate all my investments to pay off my mortgage faster. So my answer to the questions, invest or pay the mortgage faster, is to do both.

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3 thoughts on “Should You Pay Down the Mortgage Early or Invest Instead?”

  1. Agree with the pros and cons of paying mortgage versus investing. But I think it’s good to do both for the simple reason that gets you used to invest outside your mortgage and also you get used to the volatility of the sharemarket because you need to have “skin In the game” so you know what your risk tolerance is.
    However, you need to know yourself and do what’s best for your self, and no one else can tell you that. Overall it knowing yourself better-

    • I totally agree- early on I focused just on paying the mortgage as fast as we could. Now I still pay the mortgage faster than the 30 year term, but also invest in the share market through index funds. And you are right- having skin in the game is the only way to test your risk tolerance. Especially recently.


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