Pay off entire mortgage or put into investments

Question

I am currently living in a house with my family, which I see 5 - 10 more years left, until we move onto to a new home.

I have received a lump of sum of 600k that would be enough to pay off my entire mortgage of 200k.

At the moment the mortgage interest rate is at 3.75%.

At the moment I can think of two options:

1. Pay off my entire mortgage, and put the rest to stocks
2. Put everything to stocks, and pay portion of mortgage with my profits and my own income.

What would be the best way to handle this?

Answer 1

1. Pay off my entire mortgage, and put the rest to stocks

I like this option, rather than exposing all 600k to market risk, I'd think of paying off the mortgage as a way to diversify my portfolio. Expose 400k to market risk, and get a guaranteed 3.75% return on that 200k (in essence). Then you can invest the money you were putting towards your mortgage each month.

The potential disadvantage, is that the extra 200k investment could earn significantly more than 3.75%, and you'd lose out on some money.

2. Put everything to stocks, and pay portion of mortgage with my profits and my own income

Historically, the market beats 3.75%, and you'd come out ahead investing everything. There's no guarantee. You also don't have to keep your money invested, you can change your position down the road and pay off the house.

I feel best about a paid off house, but I know that my sense of security carries opportunity cost. Up to you to decide how much risk you're willing to accept.

Also, if you don't have an emergency fund, I'd set up that first and then go from there with investing/paying off house.

Answer 2

"At the moment the interest rate..." implies a variable rate mortgage. I believe rates are only going to go up from here. So, if I were in your position, I would pay off the mortgage first. If you don't have 3-6 months in savings for an emergency, I would invest that much money in low risk investments. Anything remaining I would invest in a balanced portfolio of mutual funds.

The biggest benefit to this is the flexibility it gives you. Not being burdened by a monthly mortgage frees you up to invest. This may be in your stock portfolio each month or it may be in your community or charitable causes. You have financial margin.

Answer 3

At the area where I live (Finland), banks typically charge a lot more for additional mortgage credit taken after purchasing the house. So, if you are planning to purchase a house, and pay it with a mortgage, you get a very good rate, but if you pay back the mortgage and then realize you need additional credit, you get a much worse rate.

So, if this is applicable to your area as well, I would simply buy stocks after you have paid enough of the mortgage that it is only 50% of the house price or so. This is especially good advice if you are young.

Also, if your mortgage is a fixed rate and not an adjustable rate mortgage, you probably have a very low permanent interest rate on it as interest rates are low currently (adjustable rate mortgages will also have a low rate but it will surely go up). Some people say there's a bubble currently in the stock market, but actually the bubble is in the bond market. Stocks are expensive because the other alternatives (bonds) are expensive as well. Paying back your mortgage is equivalent to investing money in bonds. I don't invest in bonds at the current ridiculously low interest rates; I merely invest in stocks and have a small cash reserve that will become even smaller as I discover new investment opportunities.

I could pay back a significant percentage (about 50%) of the loans I have by selling my stocks and using my cash reserves. I don't do that; I invest in stocks instead, and am planning to increase my exposure to the stock market at a healthy pace.

Also, consider the fact that mortgage is cheap credit. If you need additional credit for consumption due to e.g. becoming suddenly unemployed, you will get it only at very expensive rates, if at all.

If you're very near the retirement age (I'm not), this advice may not be applicable to you.

Edit: and oh, if your mortgage is fixed rate, and interest rates have come down, the bank will require you to pay the opportunity cost of the unpaid interests. So, you may need to pay more than you owe the bank.

Edit2: let's assume the bank offered you a 4% fixed rate for a 10-year loan, which you agreed to. Now let's also assume interest rates of new agreements have come down to 2%. It would be a loss to the bank to pay back the amount of the loan (because the bank cannot get 4% by offering somebody else a new loan, only 2%), unless you paid also 10 years * (4% - 2%) * amount = 20% * amount of lost interest income. At least where I live, in fixed rate loans, one needs to pay back the bank this opportunity cost of unpaid interests.