Should you pay down a mortgage — or invest?

Every homeowner with extra money in the bank has likely asked whether they should use the funds to pay down their mortgage or invest. There’s no easy answer to this question. Paying down a mortgage reduces your debt, while investing can help build wealth. Over time, either option could increase your net worth, which is the total value of your financial and non-financial assets.  

1. Consider the return on your money.

When deciding where to direct your money, you’ll want to consider current interest rates and the performance of any potential investments. Essentially, you’ll be gauging possible investment returns versus the money you’ll save on loan interest. 

It might make more sense to invest if your mortgage interest rate is low and your investment returns could be greater than that amount. However, if your mortgage interest rate is high and the market is underperforming, you may want to work toward paying off your home loan.

2. Take taxes into account.

The opportunity to deduct mortgage interest on your tax return might motivate you to continue paying down a home loan. The Internal Revenue Service provides guidelines on deducting mortgage interest. For example, on a home mortgage taken out after 2017, you can deduct interest on the first $750,000 owed on the loan. If married and filing taxes separately, that deduction amount becomes $375,000. An accountant can help you determine how much money this tax deduction could save you, and if those savings make it worthwhile to keep the debt.

3. Check for mortgage prepayment penalties.

Some lenders limit the percentage of a mortgage balance you can pay each year. If you pay more than that amount, they charge you a hefty fee. You can check with your lender or review your loan agreement to find out if any penalties apply. If they do, make note of the percentage of the mortgage you’re allowed to pay yearly without fees. Then, you can make informed decisions about payment amounts.

4. Keep the age of your loan in mind.

By paying extra toward your mortgage in the early years of your loan, you’ll end up paying less in total interest and gain more equity in your home. If your loan is older, more of your payment is going toward the principal. 

In the final years of your loan, you may want to use your money for investments since there’s less opportunity for interest savings. The Federal Housing Administration provides a quick overview of how lenders break down your payment toward the principal and interest owed. 

5. Evaluate your financial personality.

Does having debt keep you up at night? Do you worry about the risks related to investing? If so, you’ll probably want to pay down your mortgage balance for greater peace of mind. Also, when you’re approaching or in retirement, you may want the freedom of not having a mortgage payment. 

If you feel comfortable making a mortgage payment and prefer putting money into the stock market, the investing route could be the right one for you. 

6. Compare savings rates to your mortgage rate.

Before deciding where to put your disposable income, check the current savings rates. You’ll want to determine whether they’re higher than your mortgage interest rate. If they are, another secure option is to open a high-interest savings account or certificate of deposit at a bank that’s FDIC insured.

Remember, you can also choose a combined strategy of both investing and paying down your home loan. Simply add a little extra each month to your mortgage payment while also depositing some money in an investment or savings account.