Pay Off Mortgage or Invest for Retirement? Which is Best in 2023?

Having a debt hanging over your head can be frustrating. For most homeowners, their mortgage is likely the largest debt they’ll ever have.

So when it comes down to using extra cash to pay off mortgage or invest, many will want to be free and clear from debt even at the expense of possibly lucrative investments. 

However, factors like a higher return on investment can make investing a better financial decision. This article covers everything you should consider when deciding whether to pay down mortgage or invest. 

Let’s discuss what happens when you pay down mortgage or invest, the pros and cons of both options, the factors to consider, and tips to follow irrespective of the decision you make. Shall we?

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What Happens When You Pay Off Mortgage vs Invest

Paying Down Your Mortgage Early

The first side of the question is if you should pay off your mortgage. A mortgage payment is in two parts:

• The first part is the principal repayment, which will pay down the home’s actual purchase price. 
• The other part goes towards payment of the interest the financial institution holding the mortgage is charging.

For example, if you received a $60,000 lump sum payment, and you have ten years left to pay your mortgage. If you pay for it today, you’d be paying  $60,000 in principal. 

However, if you decide to keep making monthly payments till the end of the mortgage, you’d end up paying an additional $18,000 in interest payments (depending on the mortgage rate). So, paying off the $60,000 today will save you $18,000 in the long run.  

Before you pay off your mortgage, consider the interest rate on your mortgage. If it’s a fixed rate, ask yourself if the interest rate is higher than what you can afford or if you can gain from reducing the amount you owe at that high interest.  

If it’s an adjustable-rate, do you think the interest rates will increase later, and your monthly costs will get more expensive?  Your answers to these questions can help you decide. If you’re contemplating paying off your mortgage early, your mortgage lender should be your first contact. 

Depending on your loan’s terms, you may be subject to a prepayment penalty or have to follow specific parameters if you’re paying off your mortgage earlier than your payment schedule says. Having this information beforehand will help you layout a payoff plan that works for your mortgage lender and you.

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Investing in the Stock Market

The opposite side of the question is if you should invest. Consider the expected ROI (Return on Investment) before making any investment decisions. The more attractive the expected return and the higher the growth expectations, the more likely you’ll invest. 

For example, if the investment is expected to yield a 10% return each year over the next ten years and your mortgage will also last ten years. Investing $60,000 at this rate will earn you around $150,000 after ten years. 

So, it’d be a good idea to invest the money and make regular payments on the mortgage since the $18,000  interest you’ll pay would still leave you with $132,000 in profit.

However, note that the returns can not be guaranteed, and it’s not easy to achieve a 10% return. But overall, if the net after-tax return on the investment will be higher than the net interest cost on your mortgage, it could make more sense to invest.

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What to Consider Before You Pay Off Mortgage or Invest 

1. Will Paying Off the Mortgage Tie Down Your Cash?

Before you use a large option of your wealth to pay off your mortgage completely, consider your liquidity. It can take you months or even years to sell your home and retrieve the capital, so your home is viewed as a non-liquid asset. 

If you pay down your mortgage too early, you may deplete your liquidity. If your liquidity is money tied up in retirement accounts, you can be hit with fees if you decide to withdraw early for emergency needs. But if you have an emergency fund and assets like stocks, bonds, etc., you can easily convert them to cash if the need arises. 

One other good suggestion is to maintain a cushion that will protect you for at least six months before using a large chunk of your wealth to pay down your mortgage. So consider the kind of liquidity you have to know if you have a protective net.

2. Will Other Investments Yield More Than Paying Off a Mortgage Early?

When considering whether to pay down mortgage or invest, you want to know if it’s better to invest your money elsewhere rather than using it to pay off your mortgage early. 

Mortgage rates are usually low. If the return from paying off your mortgage early will be equal to your interest rate,  the return will likely be uninspiring compared to the stock market’s annual return. 

A possibly better way to use the money would be to buy a cash flow-positive property like single-family homes and multi-family real estate. These investments have the potential to yield higher returns in the long term.

However, keep in mind the risks. Even after you pay off the mortgage early, real estate prices could plummet, and you’ll have to deal with a potential loss. So be sure you’re willing to take the risk. 

3. If You Don’t Pay Down Your Mortgage, What Will You do With the Money? 

Ask yourself if you don’t pay down your mortgage with the money, will you actually invest it? Give a realistic answer to this question.

Are you someone that struggles with keeping money in the bank? Then it may be wise to put the money into paying down your mortgage. Ultimately it is a personal decision you’ll have to make. If you feel you’re going to blow away the extra cash, it’s better to put it into your house. 

4. Your Peace of Mind

Sometimes it’s more about the emotional benefit than the financial benefit. Knowing your home is all yours and you are debt-free ahead of retirement can provide you mental relief and peace of mind. 

Another benefit is you can borrow against your home’s equity. With a reasonable amount of equity, you can establish a Home Equity Line of Credit (HELOC), which serves as a source of emergency income.

Having a HELOC also allows you to make home improvements and pursue other financial goals.

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Advantages of Paying Off Mortgage

• Knowing you own your home completely gives you peace of mind.
• It gets rid of monthly mortgage payments so that you can use incoming cash flow on other obligations. 
• If you need money later, you can make use of the equity in your home.
• You save money, likely thousands of dollars, on interest. 

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Disadvantages of Paying Off Mortgage

• You will no longer qualify for the federal mortgage interest tax deductions.
• It ties up a good amount of your liquidity and wealth in your home, which you might find difficult to access later. 
• If the housing market drops and you have to sell your home quickly, you may not get as much as you hoped.  
• Paying down your mortgage could make you miss out on likely higher returns from other investments. 

Now that we’ve looked at the pros and cons of paying down mortgage let’s look at the other side. There are many reasons carrying mortgage debt can make more sense than paying it off early. Let’s see.

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Benefits of Not Paying Down Mortgage and Investing Instead

➤ You are Building Liquidity:

The major advantage of investing rather than paying down your mortgage is you’re growing a liquid asset that can put you in a better position financially. It can offer you an emergency cash fund so that unexpected expenses like health issues, sudden home repairs, a job loss, etc., will not hinder your financial goals. 

➤ Mortgage Interest is Cheap:

Other forms of borrowing like credit card debt and personal loans have a much higher interest rate than mortgages. Lenders give a better interest rate on mortgages because the home’s value secures the borrowed fund. 

➤ Long-Term Investments Surpass Mortgage-Interest Savings:

Putting the extra cash in a long-term investment will most likely yield more than mortgage-interest savings. How? Compared to the amount you’ll save on mortgage interest when you pay off your mortgage early, the rate of return on your investments will likely be higher over 25 years. (Canada’s standard mortgage amortization length is 25 years). 

➤ Tax Advantages:

You can reduce what you pay on income tax yearly by contributing what would have gone towards paying down the mortgage to a Registered Retirement Savings Plan (RRSP). Contributing to your RRSP also allows you to participate in long-term, tax-deferred growth as long as your investments remain in the account.

➤ Diverse Investments:

Investing in only your home means you’re putting all your eggs in one basket. If the housing market experiences a crash, you’ll be in trouble. However, having diverse investments that extend beyond real estate maximizes your return and minimizes the risks.

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Downsides of Not Paying Down Your Mortgage

• You have to settle monthly mortgage payments consistently for 25 years.

• Return on Investment is not guaranteed. This is the risk associated with every investment. Some investors have experienced years, even decades, of little or no return on their investments.

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Tips to Follow if You Decide to Invest instead of Pay Off Mortgage

To get the best return on your investment, we recommend following one of these approaches: 

➤ Use a Robo Advisor

A Robo advisor is a“set it and forget it” financial advisor and investment solution. They provide financial advice or investment management online with little human intervention. Our detailed guide on the best Robo advisors in Canada will help you select the right one for you. 

➤ Save in a TFSA or RRSP

TFSAs and RRSPs are tax-sheltered investment baskets that help you save towards retirement. Your TFSA or RRSP can hold several investments such as stocks, GICs, bonds, exchange-traded funds, index funds, and mutual funds. 

What sets TFSAs and RRSPs apart is how and when you are taxed on your earnings and contributions. When you contribute to a TFSA, there is no tax deduction, and your investments grow tax-free. 

The best part is you withdraw your money tax-free. The annual contribution limit for TFSAs in 2021 is $6,000, and Canadians who were 18 years of age or more in 2009 can have up to $75,500 in a TFSA.

An RRSP, on the other hand, offers its tax deduction benefits the year you make your contribution and your investments grow tax-free. 

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Tips to Follow if You Decide to Pay Off Mortgage Early instead of Investing in the Stock Market

If you decide the better option is to pay down your mortgage, your financial goals should not suffer. These are some tips you can follow. 

➤ Get Rid of High-interest Debt Before You Make Extra Mortgage Payments

Debts like car loans, credit card balances, and personal loans usually have a much higher interest rate than your mortgage. If you don’t tackle them before paying off your mortgage, you might struggle.

➤ Grow an Emergency Fund 

Before you pay down your mortgage, have an emergency fund ready. With it, you maintain liquidity and access it when you are in a fix.

➤ Invest for Retirement

When deciding whether to pay off mortgage or invest, don’t forget retirement. Put money in a tax-advantaged retirement account. When you retire, having a good retirement account in addition to having your house paid off will make your life easier.

➤ Refinance

Consider refinancing your mortgage to a shorter term, for example, switching to a 15 years loan from a 25 years mortgage. Your monthly mortgage payment will increase, but you’ll save money on interest and be out of debt faster.

➤ Look out for a Prepayment Penalty

Paying off your mortgage early may come with an extra fee. Do your calculations and see if you’ll still be at an advantage after paying the penalty.

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Post-Mortgage Money Tips

• Have you decided to pay down your mortgage? It doesn’t end there. To maintain financial stability after paying off your mortgage, follow these tips.
• If you are concerned about your job, cut out discretionary spendings and bump up your emergency funds to six months.
• Make new post-mortgage goals. Differentiate between your needs and wants and create a plan to achieve these goals.
• Prioritize your retirement savings. 

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Final Words: Pay Off Mortgage vs Invest

Ideally, no one should have to ask the pay-down mortgage or invest question. Everyone should have enough money to do both rather than decide on one. However, most of us have to make this tough decision. 

If the interest rate on your mortgage is higher than what you might make from investing the money, it may be wiser to pay down the mortgage. If it’s vice versa, you should invest the money.

Like many people, you can prioritize RRSP investments and use the tax refund to pay off your mortgage early. That way, you win both ways.

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