Early mortgage payments or investing in the stock market? – A wealth of common sense

A reader asks:

There are many financial rules of thumb out there. Do you have a rule of thumb for when you should prioritize paying off a mortgage over investing? I have a rate of 6.375% on $470,000 and I am 30 years old. How should I think about this?

I like these types of questions because there are answers in black, white, and shades of gray.

This is my general rule of thumb:

If your mortgage interest rate is lower than 4% to 4.5%, there is no point in paying it off.

Finances are personal and some people despise debt. But I cannot accept having to pay off my debts at such a low interest rate when inflation is 3%. It doesn’t make sense, feelings be damned.

Anything 7% or higher and you should seriously consider making an extra payment here or there. That’s a pretty high threshold percentage.

That means the 4% to 7% range is no man’s land. Dealer’s choice.

Some people like to make one extra mortgage payment per year. Others prefer to make an additional principal payment every month.

I had my new friend Claude create a simple mortgage calculator¹ So let’s take a look at how additional monthly payments would affect the numbers. This is what an extra €100/month would look like:

You shave a few years off the loan and make healthy savings on interest costs.

Now here’s $500/month in additional payments:

That’s not bad.

It would cost about $1,100 extra each month to convert a 30-year mortgage into a 15-year loan.

The problem is that very few homeowners live in the same home for the life of a loan and never refinance. The hope is that you can refinance your 6.375% at a lower interest rate in the coming years.

You also need to weigh your preference for debt repayment against your desire for flexibility and liquidity. Once that money is in the house, it can’t come out unless you sell it or borrow against it. If you invest in the stock market, you can always get your money back by selling.

Of course, the mortgage interest rate is a guaranteed return. There is no guarantee that stock market returns will be as high in the future as they have been in the past.

The biggest factor besides the interest rate is your age. You are only 30 years old. You have many years of compounding ahead of you. You may be moving in the coming years. You will likely refinance at a lower rate. You may decide to cash in some of your home equity to pay for a renovation.

These decisions are always personal.

I never pay off my 3% mortgage early, but 6% and change can change the calculation.

Some people have very strong opinions about these types of decisions. You always pay off the debt early, no matter what! No, you never pay off the debt before!

I don’t like to go to extremes. It doesn’t have to be all or nothing.

I like diversification in all things. Diversification of income streams. Diversification of timing contributions to the market. Diversification by asset class, geography, strategy and security.

If you decide to make extra mortgage payments, don’t completely close off your stock market investments.

They say no one ever regrets paying off their mortgage early.

No one regrets putting money into the stock market and letting it get worse over decades.

I talked about this question on the latest episode of Ask the Compound:

I also answered questions about when to turn off dollar-cost averaging in stocks, how UCITs work, home equity as a false form of wealth, owning your home for a short period of time, and how to invest in your 401k.

Further reading:
The economics of a 50-year mortgage

¹Why didn’t I just use mortgage calculators that were already available? The Claude AI version looks nicer. And it’s easier.