Dear John Smith: Should you pay off your mortgage first or invest your extra cash instead
by Zain Jaffer
Many people these days are probably wondering, just in case they have extra cash, if they should try to pay off their mortgage first or invest their money. Before I answer this question, you should probably consider talking to a registered financial adviser for your specific situation. However let me spell out my thoughts at least in general terms. Take note that the advice I would have given prior to the pandemic is very different from the situation now.
First, each person has their own financial situation. My general advice in this article will not apply to some people. For example some of them earn enough after their basic non discretionary expenses are paid so that they can actually do both, meaning they can both try to pay off their mortgage early and still do some investments. However, most people these days are probably not in that situation. So for our theoretical exercise, let’s consider people who need to make a choice between investing or paying their mortgage early.
In fact data from the Federal Reserve Economic Data (FRED) shows that personal savings from the pandemic years is starting to get depleted. In fact many people have shifted to credit card debt, which has now exceeded $1T nationally. That is problematic because credit card debt, now over 20%, can really cause havoc with your life if you do not control it.
Now if you are thinking you will invest in bonds, or stocks, or crypto, or whatever just to make greater returns to pay off your debts, theoretically that sounds good. Historically during most years, the stock market has returned around 10%. But note that this is an average, and thus in some years you make less, in some years you make more. You may even lose a lot if you manage to pick the wrong stocks or crypto. So needless to say it is not a risk free proposition.
It is understandable that making a profit on an investment gives you an adrenaline rush and a confidence from knowing that you understand the market. However the markets are not always rational. What seems like a well thought out trade can still go south.
In addition, the Fed rate hikes have made US treasury bonds more acceptable investments with higher yields. People have started to pull out some of their money from stock markets and crypto that have caused those to have less liquidity. So while interest rates remain high, and earnings go lower because of higher inflation and a possible slowdown or recession, we may no longer get the high flying stock market returns of the past few years. Take note that this is not specific to any stock, but to the indices.
On the flip side, having no more debt or just the amount of debt you are comfortable with gives you peace of mind. Peace of mind is not something trivial.
Paying off your loans with interest early is not necessarily unprofitable. In a sense you do make a profit. If each year of a mortgage charges you 8% of the loan amount, not only do you avoid defaulting and losing your house, you would have saved the 8% that would have incurred for the extra year that you did not pay the principal.
Granted you can deduct your expenses from your tax returns, so that may also be a major consideration.
The situation becomes more complex if you have a mortgage, car loan, credit card, and student debt. If you find that you will have to cut payments to some of those loans because you are not earning enough, you should really talk to a lawyer or a professional you trust who can advise you.
Generally, you should pay off your high interest loans like credit card loans on time, since these now exceed 20% per annum. On the other hand, if you have been making payments on a house for several years now, you also cannot be delinquent on those payments, else you run the risk of getting foreclosed.
There are no easy answers, but in general right now given the macroeconomic, fiscal, monetary and political situation, I would advise you to play it safe and pay your debts first if given a choice between loan repayment and investing your money to earn a greater return. While a bond gives a risk free return, the profit is taxable.
If you had asked me during the pre-pandemic years if I would recommend paying off your mortgage early versus investing your extra money, I would have probably said enjoy your low interest mortgage while making high returns from investable instruments.
These days, given all the uncertainty of wars, high government debt, macroeconomic risks, I’d probably say buy some peace of mind by owning your own home completely if and when you can.