With mortgage rates near 20-year highs, many readers are wondering if they should pay down their mortgages or invest. How should you evaluate this choice?
Let’s say you had $50k to either invest or pay down your mortgage. Here are a few things to consider:
Regret: If you didn’t pay down your mortgage and invested, subsequently losing 20-30% in a bear market how would you feel? While the US stock market has historically returned about 10% annually, the variability of that return is wide and there can be long periods of underperformance. Invest at the wrong time, and the math used in the invest vs pay down decision could require many years to work out. Meanwhile, your mortgage interest costs continue to compound.
Psychological Safety: Debt is a relentless burden. Unlike contributing to an investment plan, mortgage payments have little flexibility and the consequences of a couple missed payments can be severe. A mortgage restricts lifestyles and personal flexibility, and can strain relationships. Many people pay down their mortgages to lift this burden, regardless of whether or not the math makes sense.
Risk-Adjusted: Often, people make the naïve comparison between a mortgage rate and average market returns (ignoring tax) when choosing to invest or pay down debt. What this fails to capture is the risk of each choice. Paying down debt is a guaranteed way to reduce interest expenses by the associated rate. Whereas, the return from investing in stocks is unknown. The spread between the two numbers should be sufficiently wide to compensate for this risk.
Advice: If you seek advice on the matter, consider the incentives for the person providing the advice. Some financial advisors are compensated or evaluated on both mortgage balances and investment portfolios. Therefore, it may be in their interest to suggest investing as the ideal way to put extra cash to work. Of course, this isn’t always the case but something to watch for.