Should I Pay Down the Mortgage or Invest the Difference?

Donald Trump’s favorite game

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“Worm or beetle – drought or tempest – on a farmer’s land may fall,
Each is loaded full o’ ruin, but a mortgage beats ’em all.”
–Will Carleton

This is one of the most common questions I’ve faced as a planner. It’s a question that we ourselves faced at one time. We had a mortgage on our condo and extra income, and then, when I sold down my shares in the company I co-founded, we had a windfall of extra money coming in.

What to do with the extra money?

Pay down the mortgage or invest it?

There are two schools of thought.

Pay down the mortgage because it’s a known return.

Even if you’re already getting enough itemized deductions outside of the mortgage so that your mortgage interest can be completely deducted from your taxes, you’re still getting (1- your tax rate) * your mortgage rate as a return on your investment. Given how volatile the stock market is, it’s tempting to rest easy at night knowing that you’ll get the mortgage paid off sooner and reduce your expenses going forward.

For those playing along, this is the route that we chose.

Invest in the markets because the average return is higher than the mortgage.

The compound average growth rate of the S&P 500 from 1871 through 2013 is 9.07%. The current average mortgage rate hovers around 4.5%, so you’d be getting double the return, assuming that you got the average growth of the S&P 500 over time.

Of course, averages mean that you’d have ups and downs. You could run into a series of down years such as when the tech bubble burst or the Great Recession. Would you be able to handle the swings in your portfolio if you were making less than your mortgage rate?

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Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business. You can read more about him in the About Page. If you live in Johnson County, Texas or the surrounding areas, he and his wife are cash buyers of Johnson County, Texas houses.

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