"Remind me why you still have a mortgage."
Our financial planner put that to my husband and I a decade ago. He pointed out we weren't getting much of a tax benefit from carrying the debt because such a big percentage of our payments was going to our initial borrowing amount at the tail end of our 15-year loan.
He could also see we had the cash; it was sitting in our Vanguard municipal money market fund, earning much less than our 2.875% mortgage rate. In other words, mortgage paydown promised a higher return on our money than it was earning in our investments.
We had been hanging on to the mortgage because a mortgage rate of less than 3% seemed like a great deal (and it certainly was relative to our very first mortgage of 8.75% in 1994). But the numbers and our household balance sheet argued otherwise.
An inflation spike and plenty of rate hikes later, the calculus around mortgage paydown has changed meaningfully. People with newer mortgages (and higher interest rates) may still want to accelerate mortgage paydown versus steering cash into their investment portfolios. But many homeowners with more seasoned loans will want to hang back. That's because, now that yields and expected returns on safe investments are also higher, they can readily earn a higher return by investing than they could earn by paying down debt.
If you face the very common conundrum of whether to pay extra on your mortgage or invest in the market, ask yourself the following questions.
1. Do I Need The Liquidity?
A key starting question is whether you might need access to this money in future. If you do, that argues against steering a big share of your available funds toward paying down a mortgage. You can tap home equity via equity release if you need to, but it's obviously much simpler to dip into an investment fund if you have a cash need.
2. How Do The 'Returns' Compare?
Ask yourself this: how does the return on investment (ROI) of a mortgage paydown compare with investing in the market itself?
The core "return" from debt paydown is straightforward: whatever your mortgage interest rate is. What's interesting is mortgage holders today hold loans with a broad range of interest rates, depending on when they took out the loan or last refinanced.
Interest rates dropped significantly during the global financial crisis of 2009 and dipped lower still during the pandemic, making it a wonderful time for borrowers to secure new loans or refinance existing ones. For those borrowers securing a mortgage today, however, they'll have to clear a higher hurdle with their investments than will people with older mortgages and lower rates.
Deciding on what type of return to assume for your investments is tougher.
Because the "return" you earn from mortgage paydown is guaranteed, the most conservative investment comparison is with an investment type that's similarly guaranteed.
That's the benchmark that my husband and I used when we decided to pay off our mortgage: we had cash in our account that was earning an interest rate substantially lower than the rate on the debt we were servicing.
With today's higher yields on cash and bonds, however, mortgage paydown might not add up for people with older loans. In my recent roundup of capital markets forecasts, for example, most investment firms were forecasting a 10-year return for US bonds of 5% to 6%.
Forecasts for cash returns are generally lower than for bonds, largely because cash yields can be ephemeral; today's higher cash yields may not persist into the future, especially if start seeing interest rate cuts later this year.
3. What Life Stage Am I At?
In a related vein, life stage and time horizon can affect the attractiveness of debt paydown versus investing. More risk-tolerant types – specifically: younger people with very long time horizons until retirement – might avoid mortgage prepayment in favour of equity investing. While stock returns are not guaranteed, history suggests that over a several-decade period, they'll likely be higher than even today's higher mortgage rates.
But if you're getting close to retirement, that means your time horizon until you'll need to begin tapping your portfolio has also shortened. It also likely means your investment mix has gotten more conservative and your expected portfolio return has declined.
In that instance, your investments might not necessarily outearn your mortgage rate. Moreover, permanently (or at least semipermanently) reducing your fixed expenses by paying off your home can be more impactful to your plan than making additional investment contributions later in life.
4. Does My Mortgage Have a Pre-Payment Penalty?
While prepayment fees are less common than they once were, some lenders charge prepayment penalties to discourage early mortgage payoff. Contact your lender or read the fine print in your existing mortgage documents to see if this applies to you.
5. Do I Need Peace of Mind?
If the maths around whether to prepay a mortgage is kind of squishy – for example, your mortgage rate and your expected portfolio return are both about 5% – peace-of-mind considerations are a good tiebreaker.
What brings peace of mind varies with each individual, though. Being debt-free feels great to my husband and me, but I recently suggested mortgage paydown to a friend who is between jobs, has the cash, and is over 60. She shuddered and told me that she hated the idea of pulling down her loan balance that much and felt confident her portfolio would outearn her 5% mortgage rate. That, clearly, was the right call for her.
Christine Benz is director of personal finance at Morningstar. This piece was originally published on Morningstar.com and has been edited for UK audiences
