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Should You Pay Off Your Mortgage In Advance?

Pay off mortgage in advance
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As a homeowner, one of the most significant financial decisions you’ll make is whether or not to pay off your mortgage in advance. This is usually accomplished by adding more towards your principal via your monthly payment. 

Many people default to the conventional wisdom of simply comparing their mortgage rate to expected stock market returns and investing in whichever option is higher. But this approach is too simplistic and doesn’t consider several factors, including the variability of stock market returns, age, projected retirement cash flows, and net worth allocation (how much of your net worth is tied up in your home?).

The common rule of thumb is that if your mortgage rate is low, you shouldn’t pay it off and instead invest your money in the stock market for higher returns. Conversely, if your mortgage rate is high, you should pay it off as soon as possible. But this approach assumes that stock market returns are consistent and that you’ll have steady returns over time. In reality, stock market returns are unpredictable and vary greatly (to put it mildly).

A great example of when it didn’t make sense to invest in the market is during 2000 – 2010, the “lost decade.”

lost decace newspaper clipping
Source: WSJ, 3/26/2008

The S&P 500 annualized return during this period was -0.91%. Meanwhile, the average mortgage rate in 2000 was 8%. 

If someone had an extra $1000 a month and chose to invest rather than pay extra on their mortgage, they would have experienced a brutal decade. In this case, they would have been better off putting the extra money towards their mortgage and getting a guaranteed 8% return.

Yes, the long-term average return for the S&P 500 is ~10%, but be prepared for periods of dismal returns like this. After all, this is the price an investor must be willing to take if they want those attractive returns. 

Guaranteed Returns

It’s also important to remember that paying off your mortgage provides a guaranteed return, whereas the stock market does not. Comparing your mortgage rate to the risk-free rate is a better way to decide whether to pay off your mortgage or invest. 

The risk-free rate refers to short-term government bonds or the interest rate on high-yield savings accounts. T-bills are paying over 5%, and some high-yield savings accounts are over 4%. If you have a 3% mortgage rate but can earn over 4% at the bank, it doesn’t make sense to pay off your mortgage. Instead, you should invest your money elsewhere and compare your options again as rates change over time. See here for a list of the highest-yielding savings accounts.

Other Factors: Time Horizon & Net Worth

Age is another factor that plays a role in deciding whether to pay off your mortgage or invest. If you’re 35 years old, you probably have a different set of priorities than if you’re 60 years old. The closer you get to your target retirement age, the more it makes sense to pay off your mortgage. After all, nobody wants a mortgage during their golden years. A strong cash flow during one’s retirement is usually a strong indicator of a successful retirement.

Also, consider how much of your net worth is tied up in your home. If paying off your mortgage will result in 90% of your net worth tied up in your home, especially as you approach retirement, this is a major risk. Building up other assets (thus, diversifying your net worth) by investing this extra cash in liquid assets could be a better approach. 

Opportunity Cost & Risk-Free Rate

If you think about it, investing vs. paying off your mortgage comes down to the opportunity cost. What else could you do with that money? If you choose to invest your money, this might be the best answer, as stocks offer the greatest upside potential, especially if your mortgage rate is low. However, stocks offer the most significant upside potential over time. As I covered earlier, you may have to wait a while to realize those returns. 

However, if you choose to invest in cash, your decision is easier to calculate. If the bank rate exceeds your mortgage rate, don’t pay off your mortgage earlier. If the bank rate is lower than your mortgage rate, then choose to pay it off. 

In The End

The best money decision isn’t always the perfect financial decision. Remember that money is only a tool that should be used to try to live your best life. Life isn’t always about maximizing every dollar, so it’s important to look at both the financial and personal aspects of your decision.

There’s something to be said about having no mortgage as you enter retirement. Having a large mortgage balance can be pretty unnerving. Or feeling the flexibility to change careers or start your own business because you don’t have the cost of a mortgage. I have never heard anybody say, “I really regret paying off my mortgage.” It’s all about finding a balance that gives you the most confidence and peace of mind.

In the end, deciding whether to pay off your mortgage or invest is a personal decision that requires careful consideration of your financial goals, age, net worth, and personal preferences. By taking a closer look at your situation and weighing each option’s pros and cons, you can make an informed decision that aligns with your priorities and helps you achieve your long-term financial goals.


Ryan is the founder of Bull Oak, a fiduciary Registered Investment Advisor in San Diego. He’s been listed in InvestmentNews 40Under40 and his firm has been named one of the fastest-growing by Wealth Management Magazine.

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