Mortgage vs. investing

Should you invest with your spare cash or pay off your mortgage early? As with most financial planning decisions, the answer is not black and white.

  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print

Should you invest with your spare cash or pay off your mortgage early? As with most financial planning decisions, the answer is not black and white.

One of the most common questions facing families is whether to accelerate mortgage payments or to borrow as much as possible, make minimum debt payments and save for retirement.

In a world without emotional or behavioral biases where we all rationally evaluate the economics and make choices based on probability-weighted outcomes, the math points to investing over debt elimination.

Yet, the mortgage decision is rarely ever this simple. It depends on your specific situation—your tax rate, portfolio allocation, credit history, propensity to save and risk tolerance.

From a purely quantitative standpoint, the economic benefit to maintaining a mortgage and investing the difference is significant for most homeowners over the past several decades.

To help understand the economics of the mortgage decision, we test two scenarios: 1) a family uses $200,000 of savings for a home, and invests each month an amount that would otherwise be the mortgage payment (less the tax deduction), and 2) a family invests $200,000 in stocks and bonds while borrowing the same amount on a 30-year mortgage.

Over the course of 42 years, the family that borrows sees a positive outcome 97% of the time. The only period when paying cash would be better was between May and December 1981, when the mortgage rates ranged between 16.4% and 18.5%. If we allowed for refinancing, the mortgage-and-invest approach would be favorable at all times.

Assuming that history is a useful guide and ignoring behavioral biases, the analysis provides a compelling argument for keeping a mortgage. However, we would be remiss to ignore some of the important factors.

1. Tax rate. Generally, the tax benefit of the mortgage interest deduction is most meaningful for families with high income and significant other itemized deductions. Otherwise, there’s often little or no true tax savings from the mortgage interest.

2. Investment allocation. In the above scenario, we assume the $200,000 is invested in a portfolio of 70% stocks (Standard & Poor's 500 Index) and 30% bonds (Barclays Capital U.S. Government/Credit Bond Index) and rebalanced annually back to these targets. The more aggressive the investment allocation is, the better the mortgage and invest approach compares.

3. Credit history. In the analysis, we use the 30-year Freddie Mac mortgage rates. Borrowers with weak credit would obviously find the math of borrowing less attractive than the numbers above. Such borrowers may be better served to reduce the mortgage rather than invest.

4. Propensity to save. Maintaining a mortgage creates a form of forced savings. For those who lack a strong savings discipline and tend to spend what is available, the behavioral element favors a mortgage.

5. Risk tolerance. Investing in a portfolio of stocks and bonds is more risky than using the same funds to reduce a mortgage, and therefore, should have a higher expected return. But nothing is guaranteed with investing.

Paying off debt, on the other hand, is risk-free, which provides a substantial emotional benefit that is not measurable in dollars and cents. Some people prefer the peace of mind than a few hundred thousand dollars of potential economic gain.

The decision ultimately comes down to three paramount words of financial planning: avoid unnecessary risk. Without a definitive need to assume additional risk, it is hard to justify the mortgage and invest approach even if the potential, but uncertain, economic benefit is significant.

Topics:
  • Financial Planning
  • Investing Strategies
  • Mortgages
  • Financial Planning
  • Investing Strategies
  • Mortgages
  • Financial Planning
  • Investing Strategies
  • Mortgages
  • Facebook.
  • Twitter.
  • LinkedIn.
  • Google Plus
  • Print
This article was written by Jason Lina from Advice IQ and was licensed as an article reprint from January 21, 2016. Article copyright 2016 by Advice IQ.
The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
This reprint is supplied by Fidelity Brokerage Services LLC, Member NYSE, SIPC.
The third-party provider of the reprint permission and Fidelity Investments are independent entities and not legally affiliated.
The images, graphs, tools, and videos are for illustrative purposes only.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917.
750968.1.0
close
Please enter a valid e-mail address
Please enter a valid e-mail address
Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf.The subject line of the e-mail you send will be "Fidelity.com: "

Your e-mail has been sent.
close

Your e-mail has been sent.

Here's what we suggest you explore next

Taking your wallet on vacation? Here's how to keep it safe

Tourists are often targeted by pickpockets or thieves. Read here to learn how you can keep your wallet safe on vacation.

Like your checking account, but with some useful extras

All ATM fees reimbursed. No minimum balance. Pay bills. Deposit checks.

You might also like

Is a 700 credit score the magic number?

Credit scores are incredibly important to maintaining your personal finance. This article discusses the possibility of finding the perfect credit score.

The most effective way to pay off debt

Paying off debt can be done in a streamlined and effective manner. This article explores the best ways for you to pay off your debt.

7 shocking ways you could be hurting your credit score

Most are aware of the financial benefits associated with maintaining good credit, but few are aware of these little known ways that you could be accidentally hurting your credit score.

2% cash back on everyday purchases1

Deposit your cash rewards into an eligible Fidelity account. No annual fees.