Invest or Pay Off Your Mortgage? How to Decide

Heres how to know which way to go.

The six variables to consider

To decide between the two, Justin Goodbread, a certified financial planner in Knoxville, Tennessee, suggests you consider six variables:

• Your homes current market value

• Your mortgage interest rate

• Home appreciation in your area

• Your income tax rate

• Expectations for inflation

• An assumed rate of investment return

In an analysis on his blog, Financially Simple, Goodbread used national averages for these six parameters to compare different scenarios between investing and paying off a home loan early.

The math on each of these what-ifs favored investing over paying off a mortgage.

But, of course, Goodbread says the real answer to the question Invest or pay off your mortgage? depends on your situation. When pressed for a rule of thumb, he offered two:

PAY OFF YOUR MORTGAGE EARLY IF:

• Youre a conservative investor, in a low tax bracket with a high mortgage interest rate

INVEST IF:

• Youre an aggressive investor, in a high tax bracket with a low, 30-year, fixed mortgage interest rate

• Youre younger than 50

5 reasons to keep your mortgage

According to Goodbread and Ric Edelman, founder of Edelman Financial Services in Fairfax, Virginia, the primary reasons for carrying a mortgage -- and not accelerating payments on the principal -- include:

Homeowners need to maintain liquidity. If you have a financial emergency, cash reserves are essential. Homeowners who pour every dime into paying off their mortgage early might not have a cash cushion. Youve essentially buried the money in the walls of the house, Edelman says.

A mortgage doesnt affect a homes value. The house itself doesnt care if it has debt on it or not, Goodbread says. Over the long term, its likely to appreciate regardless of the amount you owe on it, he adds.

Mortgage interest is inexpensive. Because the mortgage is secured by the value of the home, interest rates are much cheaper than for credit cards and personal loans -- and the interest you pay is tax deductible. Its likely the cheapest money youll ever borrow, Edelman says.

Mortgage payments get easier with time. Theyre often a budget stretch for young homeowners, but with a 30-year fixed mortgage, time is on your side. As the effects of inflation and a growing income take hold, that monthly payment gets easier and easier to make, Edelman says.

Investments will outperform the interest cost of the mortgage over the long term. That scares some people, Edelman concedes, because of the stock market crash of 2008. However, hes not advocating 100% stock investments, but rather a diversified mix of investments built for a 30-year time frame. That period matches the term of a fixed-interest rate mortgage.

Wealth is created by investing, Edelman says, not by paying down debt.

Considering debt-free homeownership

But what about noted author and radio host Dave Ramseys advocacy of debt-free homeownership?

Im right; hes wrong! Edelman laughs. Hes quick to add: Dave and I are talking to two very different groups of people.

Edelman says Ramsey often advises people who in the past have demonstrated an inability or an unwillingness to properly manage their personal finances, particularly debt.

And Dave correctly recognizes that for these folks, credit is a drug, Edelman says. For them, abstinence is essential. And elimination of debt and avoidance of debt is necessary.

But for homeowners who manage debt responsibly, Getting a big, long mortgage and never paying it off is the smartest, safest strategy to use, he says.

With one caveat:Many people buy homes they simply cant afford, Edelman says. He advises limiting your mortgage to a payment that is no more than 30% of your income, before taxes and deductions.