Pay Off Mortgage or Invest? Here’s How To Choose

One of the most frequently asked questions in personal finances relates to mortgages and investing: is it better to pay off your mortgage or invest your money?

The truth is that there’s no clear-cut answer to this question – it depends entirely on your personal financial circumstances in addition to your personal preferences.

This article explores the factors you need to consider before making your decision.

Prerequisites

Before tackling your mortgage or crafting your investment portfolio, you need to ensure certain crucial aspects of your financial house are in order.

Two key areas to address are high-interest debt and savings.

1. High Interest Debt

Paying off your mortgage or investing requires a considerable amount of excess cash – you may need to use every last dollar you can find.

The task can prove exceedingly difficult if you are responsible for repaying numerous loans with hefty interest rates.

The interest charges alone will gobble up a large chunk of your disposable income.

For example, the average credit card interest rate is 20%, and some cards charge as high as 30%.

Unsecured loans and lines of credit can come with similarly high rates, especially if you have poor credit.

Thus, it’s wise to prioritize wiping out your high-interest debt before proceeding further.

2. Savings Fund

Whether you invest your money or use it to pay off your mortgage debt, either activity will quickly deplete your available cash.

As a result, you’ll risk falling behind on your bills and other debt obligations.

Before proceeding, you’ll want to ensure you have sufficient cash reserves to handle recurring and unforeseen expenses.

Ideally, you want to avoid situations where you are strapped for cash and resort to credit cards or borrowing from other sources just to get by.

There’s no set rule on how much money to set aside, but three to six months of your regular expenses a good target.

Key Considerations When Choosing Between Paying Off Your Mortgage or Investing

  Pay off Mortgage Invest
Age Older Younger
Mortgage Interest Rate High Low
Investment Strategy Conservative Aggressive
TFSA/RRSP Contribution Room Little or no contribution room left Considerable contribution room left

1. Age

A robust and well-designed investment portfolio can generate very lucrative returns.

Still, those returns are usually realized over many years, even decades.

It helps tremendously to have time on your side when it comes to investing, so the younger you start, the better.

By investing steadily over many years, you’ll benefit from the “magic” of compounding, generating an exponential growth in your portfolio.

Plus, you’ll have more time to ride out any downswings that affect your investment portfolio.

As a result, you should focus heavily on investing rather than paying off your mortgage if you’re young.

However, if you’re an older individual, you may have insufficient time to realize significant gains from your investments.

Also, once you retire, your employment income will cease, leaving you with a shortfall each month.

It’ll be challenging to juggle mortgage payments and ongoing household expenses with less income.

For these reasons, you should prioritize paying off your mortgage if you’re an older individual.

2. Mortgage Interest Rate

If you pay a steep interest rate on your mortgage, it’s wise to speed up the pace at which you pay down your outstanding balance.  

By doing so, you’ll avoid paying a massive amount of interest, which can add substantially to your total mortgage cost over time.

However, if you pay a low rate on your mortgage, it’s not worth scrambling to pay off your balance.

In this scenario, your interest expenses are likely manageable, maybe even negligible, especially if you’re a high-income earner.

Browsing the financial markets for investment opportunities would be a superior option.

3. Investing Approach

Do you consider yourself to be a conservative investor or an aggressive investor?

With a portfolio packed with risky investments, you’ll have the possibility of earning exceedingly high rates of return.

However, you’ll also be at the mercy of tremendous volatility that can swiftly erase your gains.

You may want to commit to a more conservative investment strategy and settle for lower returns if the latter prospect fills you with anxiety.

If you’re a risk-averse investor, using your excess cash to pay off your mortgage is a more suitable financial strategy to employ.

You’ll save the mortgage interest, rather than possibly only earning meagre returns on an investment.

Conversely, if you’re an aggressive investor, you benefit more by pursuing investing.

Key Insight

A common asset allocation rule of thumb is to hold a percentage of your wealth in stocks equal to 100 minus your age. So, if you’re 30, stocks should constitute 70% of your portfolio.

4. TFSAs & RRSPs

Both TFSAs and Registered Retirement Savings Plans (RRSP) have a contribution limit, which caps the amount you can invest in any given year.

If you’ve not reached these limits, investing is a superior option.

The benefits of tax-sheltered investment income usually outweigh the interest savings resulting from paying down a mortgage.

On the other hand, tackling your mortgage debt is more sensible if you lack TFSA or RRSP contribution room.

Scenario: Paying Off Your Mortgage

Let’s assume you recently got approved for a mortgage with the following attributes:

  • $400,000 principal
  • 75% fixed interest rate
  • 25-year amortization period
  • Monthly payments

You also can apply an extra $1,000 toward your mortgage payment each month.

Here’s what your mortgage will look like after ten years under both scenarios:

  No prepayments added to the mortgage Prepayment added to the mortgage
Monthly payment $2,050 $3,050.22
Total interest paid $128,510 $103,405
Total principal paid $117,516 $262,621

By contributing an additional $1,000 to your monthly payment, you’d save $25,104 in interest costs.

Pros of Paying Off Your Mortgage Early:

  • Interest Savings: You could save thousands of dollars in interest costs per year by applying additional payments toward your mortgage balance.
  • Increased Disposable Income: You’ll have more money available for other expenditures and investments by lowering your interest costs.
  • Building Home Equity: By focusing on paying down your mortgage, you’ll build up your home equity, which you can then access through a home equity line of credit (HELOC) should you choose.

Cons of Paying Off Your Mortgage Early:

  • Missed Investment Opportunities: Using your spare cash to pay down your mortgage means you won’t be able to invest it in various assets like stocks, bonds and rental properties.
  • Wealth is Not Very Liquid: Converting your home equity into cash is difficult and costly. Sure, you can sell your home, but it could take months to close a deal. You can also apply for a HELOC or cash-out refinance, which entails taking on debt and paying the obligatory interest charges.
  • Prepayment Penalties: Depending on your mortgage contract, you could face steep prepayment penalties should you apply for extra payments against your balance.
Couple comparing paying off mortgage vs investing with tablet on desk

Scenario: Investing First

Continuing with our example from above, let’s suppose you decide to invest the extra $1,000 rather than use it to pay down your mortgage.

You decide to invest in an index fund that tracks the S&P/TSX Composite Index, which experts forecast may provide an annualized return of 7.5%.

You’ll deposit $1,000 into your investment account at the beginning of every month while continuing to service your mortgage.

After 10 years, your investment account would be worth $179,042.

With total contributions of $120,000 ($1,000 x 12 months x 10 years), your return amounts to $59,042.

Meanwhile, your total mortgage interest expense during the 10-year time frame would be $128,510.

As a result, you’d lower your interest cost by $69,468 ($128,510 – $59,042), which is considerably more than if you used your excess cash to pay down your mortgage ($25,104).

Pros of Investing First

  • Earn Superior Returns: Stocks, commodities, real estate, and emerging assets like cryptocurrencies can potentially generate higher returns than any money saved through debt reduction strategies.
  • Better Liquidity: Sstocks, bonds, GICs, and other financial assets are liquid investments, so you can easily convert them into cash when needed.
  • Matching through Employer-Sponsored Pension Plans: Some employers offer their employees retirement accounts where they match their investment contributions up to a predetermined limit. If you have the opportunity to enroll in such a plan, you should do so, as you’ll essentially receive free money from your employer.

Cons of Investing First

  • Investing is Risky: Your portfolio could experience periods of very high volatility, mainly if you’ve selected highly-speculative investment products. You could potentially lose a significant amount of money, especially if you don’t exercise proper risk management.
  • Neglecting Mortgage Debt: If you’re struggling with your mortgage payments, it may be more prudent to come up with a plan to settle your balance owing sooner rather than later. If not, you risk losing your home to foreclosure.

Fact

The S&P/TSX Composite Index lost 35% of its value in 2008 as a result of the Global Financial Crisis.

Frequently Asked Questions

  • Why is it not a good idea to pay off your mortgage?
  • What to do after house is paid off?

Mark is a freelance writer who specializes in covering personal finance topics related to investing, mortgages, credit cards, and more.

He is passionate about educating people on how the financial markets work and providing tips to help them better manage their money. Mark holds a bachelor’s degree in finance from the Northern Alberta Institute of Technology and has more than a decade of experience as an accountant.

Outside of writing and finance, he enjoys playing poker, going to the gym, composing music, and learning about digital marketing.