Should I pay down my mortgage or invest it?

If you could secure a £200,000 mortgage for your dream home for 30 years, with a 4.5% (which admittedly is on the historically higher end) and a monthly payment of £1,013 (minus taxes and insurance), would you take it?

If you do, you will be paying close to £164,813 (82% of the actual mortgage) in interest alone for the mortgage in 30 years, according to this mortgage calculator.

Meanwhile, if you manage to add an extra $250 extra cash every month, you save up to £56,513 in interest, while reducing your mortgage term by 9 years!

What’s more, if choose to use the extra cash to invest in the stock market with an 8% average annual return (taking into account the same new duration of 21 years), you would earn £157,996, which is almost 3 times what you’d save if you paid off early. By this time, you will have £116,591 left to pay. Paying off the balance early at this time clears the total debt, and leaves you an extra £41,405 profit.

The potential is even bigger if the stock market keeps rising.

Considering both scenarios and given the chance, would you prefer to completely pay off your mortgage early with your extra cash or invest the extra cash?

Before we can conclude on which way to go, let’s take a critical look at what each option brings.

Advantages of Paying Off Your Mortgage Early:

Savings on Interest: Because interest on your mortgage accrues over time and depending on the duration, they can make a large portion of your entire mortgage due you; you enjoy the benefit of paying much lesser interest rates on your mortgage in the end. This is one major reason why you want to pay off your mortgage quite early. You simply save all the extra money you would have spent on interest payments.

Early Equity Building: This is another major benefit of paying off your mortgage early. If you can cut down the mortgage duration from 30 years to 10 years by paying off your mortgage faster, you stand the chance of building your equity in the house faster. Thus, in no time, you could use your equity in the house to refinance another mortgage, take a home equity loan for another personal project or use the new loan to add value to the house. It’s like killing two birds with a stone.

Gain Peace of Mind: Not everyone may have the emotional and psychological capacity to go through the hustle to follow through a long-term loan settlement. If you are that type, then your peace of mind is guaranteed when you pay off your mortgage early (though you still have property taxes to deal with in the future).

Bragging Rights Assurance: Sometimes, you may just want that right to say, “This is my home, fully funded”. However, that may not be forthcoming because you don’t fully own the home yet. However, if only you can pay off your mortgage earlier, you have the guaranteed right to “brag” about your new home.

Disadvantages of Paying Off Your Mortgage Early:

There is an Opportunity Cost: Paying off your mortgage early may be a great idea, but there is a price to pay. Paying off your mortgage early means you are likely “blocking” off all other major personal financial obligations or goals such as your retirement savings and emergency funds for a while. You may also not be able to take advantage of interim opportunities with great returns.

Locks Up Your Wealth: Unlike funding, a profitable business where you’re assured of some profits now and then, putting most of your cash into a home rather locks your money up, at least for a relatively long time. Homes are not easy to “liquefy” into cash later should you decide to sell your home later. In most cases, it may take quite a long time to sell it when you finally decide to.

Lose Out On Some Tax Breaks: Putting money in retirement accounts and other similar accounts usually grant you some tax breaks. Meanwhile, mortgage interests do get some tax deductions too. Thus, by paying off your mortgage early, you miss the tax breaks you could get from your retirement account and pay some possible taxes on top of your mortgage interest.

With that said, let’s switch to the “other side”.

Advantages of Investing Extra Cash:

Higher ROI: ROI (Return on Investment) is unsurprisingly higher in long-term investments than in paying off a mortgage. Unless there is a tragic event or a collapse of the market, higher earnings are assured.

Ease of Liquidation: It is quite easier and relatively faster to liquidate your funds in an investment like the stock market than it is for a home. Therefore, in times of emergencies, you can easily fall back on the possibility to get your money back.

Some Tax Breaks: Investing in a retirement account may secure you some tax breaks in certain situations. You get to take advantage of them.

Opportunity for Employer Match: Some employers offer a match-up for their employees’ retirement investments. Thus, you invest £10000; they match it up with £10000. If your employer offers such an opportunity, that is free money you are earning on top of your investment.

Disadvantages of Investing Extra Cash:

It Is Risky: Every investment has some level of risk attached to it. The high the risk, the bigger the returns. Though investing in a stock market may yield higher returns (in the long term), it is generally a volatile market compared to housing on annual basis. It is therefore important to jus not invest, but to know and understand exactly what you are investing in, the risks, and the timelines involved.

Prolonged “Debtor” Tag: You do not fully own your home until you fully pay your entire mortgage. This means, at any point in time that you do not fully pay, you can lose the house. Thus, so long as you invest your extra cash, you continue to be on the “debtors list” of the bank, and not everyone sees that to be “cool”.

Possible to Spend Your Investment: Times change and life happens. When they do, we usually rely on our savings and investments. Depending on the degree of “demand” life makes on you, and the ease of access to your investments, there is always a temptation to use up your investments originally meant to offer a buffer to your mortgage payments.

What If You Could Do Both?

Well, the short answer to whether you could do both paying off your mortgage early and investing at the same time is a sure “yes”. It is all about strategy.

If you have the power to cut off 10 years if you pay early but don’t also want to miss out on the “goodies” investments bring, you could do a “50-50” split. Thus, you spend 50% of your extra cash on your mortgage interest while investing the remaining 50% in a stock market.

If you are more aggressive, you could increase the percentage for the interest, and invest the rest in a high-paying but less volatile investment. It may take a bit of research and time, but it will surely pay off.

Nevertheless, the choice is always yours to make considering your goals and time. No choice is wrong or right so long as it suits you and is to your advantage especially now that mortgage rates are relatively low.

Links that may help you

We recommend MoneySuperMarket to compare mortgage providers.

If you’re looking to invest we have our investment guides to help you