Should I Pay Off My Mortgage or Invest the Money?

Written by: Doug Milnes

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Our Analysis of Historical Returns over 43 Years Indicates Mortgage Pay Down Has Won Out More Often

It's a question every savvy borrower thinks about: Should I pay off my mortgage and be done with it? Or should I take the mortgage company's money and try to get a better return in the stock market?

To answer that question, we analyzed historical mortgage rates as reported by Freddie Mac and the S&P 500 returns over a 43-year period. Our initial inclination was that the stock market would beat paying down your mortgage, but mortgage paydown proved a stronger contender than we expected. As an investor, what "wins" for you depends on your investment horizon and tax situation.

Historic Rates 1971 - 2013

Which Strategy won

A note about our analysis: We have performed this analysis to give insights into this question and made a number of assumptions along the way, which we call out. At the end of our article, we've outlined our analysis for review. Also, it bears saying: past performance is not necessarily indicative of the future. No one actually has a crystal ball.

Head-to-head: 30-year fixed wins more often

For the 43 years starting in 1971 and ending in 2013, paying down a mortgage at that year's average mortgage rate was a better financial move than investing in the S&P 500 in 26 of those years or 60 percent of the time. Looking deeper into the results, if you had gotten a mortgage any time during or after the financial crisis (2008 through 2013), investing in stocks was a winning strategy. The S&P's compounded annual return over the five years following 2009, 15.29 percent, handily beat the average 30-year fixed rate of 5.04 percent. From 1997 to 2007, which includes the dot-com bubble and the lead-up to the financial crisis, paying down your mortgage was a winning strategy 10 out of 11 years.

5-year S&P 500 returns versus 30-year fixed rates
Winner Win Rate
30-year Fixed 60% (26-17)

We were curious about longer periods of time invested in the stock market and re-ran the numbers, comparing the 30-year fixed to the 10-year S&P returns. For the 10-year return rate, the result is similar to the five-year period: paying down a mortgage was a better return than the stock market 63 percent of the time or 24 out of 38 years. Surprisingly, paying down your mortgage would have been a better use of your money than investing in the S&P 500, even for a 10-year period.

10-year S&P 500 returns versus 30-year fixed rates
Winner Win Rate
30-year Fixed 63% (24-14)

For most Americans, including taxes favors paying down mortgages

Our initial analysis above doesn't factor in the impact of taxes. A common argument about this type of analysis is the different tax treatment of stock returns and mortgage interest. Usually you get more benefit from stocks, due to a lower tax rate for stock gains. However, recent changes in the tax code actually give an edge to the 30-year fixed for many Americans.

The Tax Cuts and Jobs Act of 2017 reduced the use of itemized deductions, such as mortgage interest, because the standard deduction increased. Now, 82 percent of homeowners have standard deductions large enough that the mortgage interest deduction isn’t providing a tax benefit to them. Those who do benefit from deducting mortgage interest have a tax bracket of 24 percent.

Stocks held longer than a year are subject to long-term capital gains taxes, which, for the majority of Americans, is 15 percent. Here’s how this might work out. Say that both mortgages and stocks have a rate of return of 10 percent. Tax affecting the mortgage rate at 24 percent would create a rate of return of 7.6 percent while the comparable stock return tax affected at 15 percent would be 8.5 percent.

We put together two scenarios to understand the impact of taxes. In the first scenario, we taxed only stock returns and did not factor in the benefits of deducting interest. In the second, tax is factored into both stock returns and mortgage interest. With the S&P trailing the 30-year fixed in our original scenario, it’s no surprise that lowering the returns on the S&P for taxes while leaving mortgage rates unchanged tips the scales further toward the 30-year fixed. When both strategies are tax affected, the results get closer to an even race, and the S&P forces a tie when reviewing 10-year returns.

5-year S&P 500 Returns versus 30-year fixed rates
Scenario Winner Win Rate
Head to Head (original) 30-year Fixed 60% (26-17)
S&P 500 Tax Affected 30-year Fixed 70% (30-13)
Both Tax Affected 30-year Fixed 53% (23-20)
10-year S&P 500 Returns versus 30-year fixed rates
Scenario Winner Win Rate
Head to Head (No Adjustments) 30-year Fixed 63% (24-14)
S&P 500 Tax Affected 30-year Fixed 84% (32- 6)
Both Tax Affected Tie 50% (19-19)

But aren't retirement accounts tax-exempt?

Retirement accounts such as the 401(k), Roth IRA, and Traditional IRA accounts are tax exempt while the money is invested, making them a great place to compound your money tax-free. If your investment goal is retirement accumulation, the tax treatment of retirement accounts is a reason to consider investing in the market rather than paying down your mortgage.

We're going to interrupt our analysis for a moment for a public service announcement. If your employer matches your contributions in a 401(k) or you're investing in another retirement plan that you have not maxed out, your choices are easy. Max out the matching plan first. By participating in your matching program, you'll achieve a 100 percent return ($1 becomes $2) even if you keep your dollars in cash. You’ll be beating both the stock market and whatever rate you have on your mortgage.

Now back to our regular analysis. Given that most homeowners will be taking the standard deduction, the scenario where the S&P 500 is in a tax-exempt account is actually our original scenario where neither is tax affected. For the relatively few people getting a tax benefit from mortgages, this is the scenario where the S&P 500 wins more often than paying down your mortgage.

Other considerations for your situation

  • You have other higher interest rate debt

    If you're carrying other high interest debt like credit cards, focus on these first. If you have an APR above 17 percent, paying down your credit card is a better return than both the S&P and your mortgage.

  • You are risk averse

    You shouldn’t be investing in the stock market if you won't be able to stomach a sharp decline or your time horizon is so short that you won’t be able to recover. There are investment questionnaires online you can take or consult with a financial advisor to help you find a portfolio that will let you sleep at night.

  • You need cash or have a very short timeline

    If you need cash or need to have a cash reserve for emergencies, neither the stock market nor your home equity is the place to do that. Selling your stocks in the event of an emergency may mean selling at a loss. Getting at the home equity that you’ve built by paying down your mortgage requires taking a home equity loan or, worse, selling your house — neither of these is ideal for accessing cash in a hurry.

  • You are eligible to refinance

    Our analysis doesn’t consider the opportunities to refinance your mortgage along the way. Refinancing can have the benefit of lowering your monthly payment and reducing your total interest paid. This can be a great move for you financially if the interest rate drop covers your refinancing fees. Use the money you save on a refi on a monthly basis to fuel more saving. Even after a refi, you’re still able to pay down your mortgage if you feel that will give you a better return than elsewhere.

Learn More >>
MoneyGeek's Guide to Refinancing
MoneyGeek’s Refinance Calculator

Overall, mortgage payoff has an edge in these scenarios

Looking back, we were surprised to learn that paying down your mortgage was a real contender, more so than we would have initially guessed. It was a real lesson in stock market volatility to see that the mortgage has outperformed over these time horizons (five and 10 years). Here’s the final scoreboard:

5-year S&P returns versus 30-year fixed
Scenario Winner Win Rate
Head to Head (No Adjustments) 30-year Fixed 60% (26-17)
S&P 500 Tax Affected 30-year Fixed 70% (30-13)
Both Tax Affected 30-year Fixed 53% (23-20)
Mortgage Tax Affected (S&P in retirement) S&P 500 56% (24-19)
10-year S&P returns versus 30-year fixed
Scenario Winner Win Rate
Head to Head (No Adjustments) 30-year Fixed 63% (24-14)
S&P 500 Tax Affected 30-year Fixed 84% (32-6)
Both Tax Affected Tie 50% (19-19)
Mortgage Tax Affected (S&P in retirement) S&P 500 68% (26-12)

But you should diversify between these investing choices

The reality is you should be pursuing both strategies with your extra cash. Picking the winner in a given year is hard or even impossible. With a win rate between 60 and 63 percent for mortgages, there's room for a longer period when stocks win for years in a row. In fact, we've been in one of those periods. Since 2001, both five-year and 10-year returns of the S&P have won more often than the 30-year fixed. Diversifying your portfolio with both investments decreases your risk profile. While the S&P moves through its ups and downs, paying down your mortgage (if it’s fixed rate) provides a guaranteed rate of return.

Here's what the data tell us you should be doing:

  • Pay down high interest rate debt first -- it’s a better return than either the market or your mortgage and that extra cash is immediately available to you.
  • Assuming you have retirement to plan for, max any employer match available to you for immediate 100 percent returns on your investment.
  • Look for opportunities to refi. In our mortgage trends analysis, we found that if you got a mortgage in January 2019 and refied in October 2019, you would have saved over $100 a month and recouped your refinancing fees in a couple of months.
  • Assess your goals and situation to choose the right mix for you. Short time horizons and lower risk tolerance should favor paying down your mortgage, especially if you’re not deducting your interest on your tax return. Longer time horizons in a tax-exempt account favor investing in the market.

Analysis assumptions & notes

  • Basics of the analysis:

    We started with this premise: What if you financed a home in a given year and you had an extra dollar to spend? How should you use that extra money?

    If you pay down the mortgage, you'll pay down the principal and get a benefit of avoided interest at the current 30-year fixed rate.

    In the scenario of investing in the S&P 500, we used the next five or 10 years of compounded annual returns, assuming you would buy and hold for a period. For this reason, our analysis ends in 2013, the last year in which we have five years of returns to calculate (2018). We’ve ignored fees and commissions for both the mortgage and the S&P 500 as a simplifying assumption.

  • Mortgage interest tax benefit of 24 percent:

    Reviewing the 2018 tax return data from the IRS collected through July 2019, we found that over 50 percent of returns using the mortgage deduction were incomes between $75,000 and $200,000. We’ve assumed a 24 percent ordinary income tax rate for this group based on the current tax rates.

  • Paying down your mortgage is guaranteed statement:

    Home equity is not guaranteed, however, your mortgage exists regardless of your equity. Each dollar that you pay down lowers the total interest paid on your mortgage and makes future mortgage payments reduce a larger percent of your loan principal.

  • Data used for this analysis:

    Internal Revenue Service Mid-July Filing Season Statistics by AGI, Tax Year 2019 Inflation Adjusted Tax Rates.
    Joint Committee on Taxation, Tables Related to the Federal Tax System as in Effect 2017 through 2026.
    Freddie Mac Primary Mortgage Market Survey accessed 10/21/19
    S&P 500 average annual value 1971 through 2018.

More about the writer: Doug Milnes is the head of marketing and communications at MoneyGeek. He learned about personal finance from his parents who were experts in insurance and retirement services at Prudential. He has spent more than a decade in corporate finance performing valuations for Duff and Phelps and financial planning and analysis for various companies including OpenTable. He holds a master’s degree in Predictive Analytics (Data Science) from Northwestern University and is a CFA charter holder. Doug geeks out on building financial and predictive models and using data to make informed decisions.