My mortgage is 3.5% fixed rate. I have enough money to pay off the remaining balance, and still have enough left over for an emergency fund.

My investments have historically made more than 3.5% per year, and I'm fairly confident that I can make an average rate of 3.5% or more going forward. (Not guaranteed, of course, because there is still risk).

Does it make sense to forgo paying off my mortgage early and just invest that money? Other than investment risk/returns, what other factors should I consider?

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    Have you factored in taxes? What country are you in? – Chris W. Rea May 28 '16 at 12:25
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    When my family had some health issues and things were very uncertain, I decided to pay off our mortgage even though my average investment return over the last 15 years is 9%. Not having a mortgage payment to make reduced the uncertainty in other places, which helped me make that decision. – Peter K. May 28 '16 at 14:33
  • @ChrisW.Rea what do you mean by factoring in taxes? If you mean property taxes OP is paying those one way or another, wether its through escrow or directly. I think that is a budgeting point. If the mortgage interest is deductible OPs taxes might go up, but OP also now has more money to spend every month and cover the lack of a deduction. How else do taxes factor in to paying off a mortgage or not? – Freiheit Feb 9 at 19:31
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    @Freiheit Just re-read your comment and noticed you're aware of the potential deductibility of interest available in some places. The other factor would be the rate of taxation (or not) on the investment returns. Essentially, for an apples-to-apples comparison, taxes matter. In Canada, for instance, there are at least four different tax rates on different types of investment income: interest vs. capital gains vs. eligible dividends vs. non-eligible dividends. – Chris W. Rea Feb 9 at 20:49
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    @Freiheit And to extend my Canada example, there's no mortgage interest tax deduction for a principal residence, but, say, paying off a home mortgage and then reborrowing funds for investment purposes can make the new loan interest deductible against the investment income, provided the investments are not held in a tax shelter. – Chris W. Rea Feb 9 at 20:56

Welcome to Money.SE. Please forgive what might sound like a cliche, "How well do you sleep at night?" I mean, specific to the mortgage. There are those who are in a group who consider debt, at any rate, to be inherently bad, and would not take on a 2% mortgage even if a different bank were offering 4% CDs. You just need to understand the risk.

Your mortgage cost after taxes may be 2.625% (if you are in the 25% bracket) therefore, your break even is 3.09% for long term investments. The recent "lost decade" had a return of -9.5% for the full 10 year period. This is just about the worst decade in modern history. The average 10 year return is a cumulative 183% gain, with a standard deviation of 138%. If a perfect bell curve, this means that 1 10 year in 6 will give you a return under 45%. In fact, of the last 100 10 year periods, 15 had returns less than 45%, and just 8 were less than 30%, right in line with the bell curve stats.

We always need to say "past performance is no guarantee of future results," yet, when it comes to the market (I use the S&P for my numbers, by the way) we do have history to give us an idea of the kind of volatility we might see over the years. In my opinion, your approach is sound, and your returns very skewed to the positive, the median 10 year return being 138%, vs your cost of money of 40% or so for a decade.

It's pretty easy to pull S&P data into a spreadsheet and analyze as you wish.

  • 45% and 30% are for 10 year periods? If so there's a sentence that should read something like "this means that 1 ten year period out of 6 will give you a return under 45%". Also, you mention the tax deduction for mortgage interest but don't include taxes on the investment gains. – stannius May 31 '16 at 23:59
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    Yes, I fixed that. 1 10 year period in 6, or a 1 in 6 chance that a 10 yr period will be lower. I did say the break even on gains is 3.09%/yr, (taking tax into account. LT gains at 15%) which compounds to the 40% or so goal. – JoeTaxpayer Jun 1 '16 at 0:10

If your house was paid off, would you be comfortable borrowing from the equity to invest?

This is essentially the same question.

Also, why not ask the opposite? How much more should you be borrowing (at a similar rate) for investments?

Your answer to both questions will be clues to how you view the risk/reward of borrowing against your house in order to invest.

My personal preference is not to invest with borrowed money. There may be a few percent of potential returns I am missing out on. That percent return has to be analyzed in the context of a full financial plan and future goals.

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    I would like to contend that if you have both a mortgage and any kind of investment account, you are, in fact, "investing with borrowed money"... – ljwobker Jan 17 '17 at 15:07
  • @ljwobker I agree. My answer would still be the same. I would still prefer to pay off debt before any investing, and would cash out investments to pay debt. This is only investments outside a retirement account (assumed from OP's original question context). Others will be ok with more risk, obviously! – jkuz Jan 17 '17 at 17:55

Advantages of paying off debt:

  • Smaller "nut". You do not need as much cash flow every month to keep up with your obligations. This can give you
  • The freedom to move, quit a job, et cetera, which can give you
  • A better negotiating position at work, and when considering job offers.
  • Reduced dependence on the government, courts, and the financial system to enforce your property rights in your investments (that allow you to satisfy your debt obligations).
  • A feeling of relief about being "debt free".

Potential advantage of remaining in debt:

  • It is possible that at some point in the future, high inflation might dramatically reduce the amount of goods and services required to pay off the debt.
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    What about "your returns may be well above your cost, a couple decades of 10% returns vs 3% cost will put you well ahead of the pre-payer"? – JoeTaxpayer May 28 '16 at 17:26
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    "the freedom to move, quit a job, et cetera" - I don't understand how a paid -off mortgage gives you this freedom where having the same amount of money in the bank wouldn't? – Joe Strazzere Jun 1 '16 at 20:02
  • @JoeTaxpayer -- The question was about "Other than investment risk/returns, what other factors should I consider?" I therefore described other factors (mostly psychological and freedom-related). – Jasper Jun 3 '16 at 2:57
  • @JoeTaxpayer -- I do not know of a non-direct, non-leveraged investment that can be expected a priori to return an average of 10% per year for 20 years. – Jasper Jun 3 '16 at 2:58
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    @Jasper - he wrote "I have enough money to pay off the remaining balance". So having the money to pay off a mortgage, but keeping it in the bank gives you exactly the same freedom to move, quit a job, etc, as actually paying off the mortgage. You additionally have more liquidity which I would argue gives you even more freedom. – Joe Strazzere Jun 3 '16 at 16:57

I would recommend not paying it off early for 2 key reasons:

  1. If you are a resident of the U.S. you get tax deductibility of mortgage interest, which as pointed out in previous posts, reduces the effective interest rate on your mortgage, never in your life will you ever be allowed to obtain such high leverage at such a low rates.

  2. You can probably get higher returns with not much risk. @JoeTaxpayer mentioned various statistics regarding returns when investing in equities. Even though they are a decent bet over the long term, you can get an even better risk reward tradeoff by considering municipal bonds. If you are in the U.S. and invest in the municipal bonds of your state, the interest income will be both federal and state tax-free.

In other words, if you were making 3.5% investing in equities, your after tax returns would be significantly less depending on your tax bracket whereas investment-grade municipal bond ETFs will yield probably the same or higher and have no tax. They are also significantly less volatile. Even though they have default risk, the risk is small since most of these bonds are backed by future tax obligations, or other income streams derived from hard assets such as tolls or property. Furthermore, an ETF will have a portfolio of these bonds which will also dampen the impact of any individual defaults.

In essence, you are getting paid this spread for simply having access to credit, take advantage of it while you can.

  • +1 with a warning - If you have a mortgage in place, this advice is fine, to invest this other money as you wish. But, you are not allowed to deduct the interest on freshly borrowed money invested in tax frees. – JoeTaxpayer May 29 '16 at 14:23
  • @JoeTaxpayer why wouldn't you be able to deduct the interest? Even if it's not deductible like normal mortgage interest, wouldn't it be deductible as an investment expense? – stannius May 31 '16 at 23:55
  • Nope. There's a specific IRS rule about this. One of the many obscure regulations that can trip people up. I suggest you search on it. I am certain of it but don't have a link handy. – JoeTaxpayer Jun 1 '16 at 0:06

The main reasons not to pay off your mortgage early are:

  1. You shop around various banks and discover that your current mortgage rate is fixed at a lower percent than most other banks are offering on new mortgages today.

  2. Everybody seems worried about or is experiencing inflation.

  3. You are not restricted in what you can invest in, and your investments are getting a better return than your mortgage rate.

  4. You are uncertain about your job security.

  5. You wouldn't have much cash left after paying down the mortgage early.

  6. You get insurance that would be difficult to obtain without a mortgage (coastal hurricane/flood insurance)

The main reasons to pay off your mortgage early are:

  1. You have restrictions on what you can invest in either legally or contractually, an you don't have any other higher-rate debt.

  2. Mortgage rates are dropping or you are able to get a new mortgage at a lower rate (refinance)

  3. You have a variable-rate loan and don't want the stress of it hanging over your head.

  4. You think you might be sued. They can't come after your home if you have a homestead exemption in some states, but they can come after your cash.

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