Ask the grumpies: The mortgage vs. stocks question (in a low interest rate, high inflation environment)

OMDG asks:

We’ve recently purchased a house — yay! I’d always planned on paying it down quickly, but I’ve recently heard advice that given the low interest rate on our mortgage, we would be better off putting the $ in an index fund, since the gains in the market are expected to be higher than we would have to pay in extra interest if we were to pay off our mortgage early. However… as with all things, whether this is good advice depends on the trajectory of the stock market remaining as it has been for the past several years. In the absence of perfect information and me being a risk averse person, I decided instead to split the difference, i.e. half my extra $ to principal on the mortgage, and half in an index fund. I should also add that we are maxing out our 529 and our tax advantaged retirement savings already. Does this seem like a reasonable approach? What would you do differently?

Disclaimer:  We are not professionals.  Talk to a certified no-fee financial planner or do your own research before making any major money decisions.  (We could be totally wrong!)

Congratulations on your purchase!

We know a little bit more than when we last tackled this question.

If your interest rate is in the 2-4% range, it is unlikely that the stock market will be less than that over the period of the 15 or 30 years that your mortgage will last, even with risk adjustments etc.  Even if you’re planning on only being in the market for a very short term, the stock market is likely to come ahead when there are really low interest rates.

Currently inflation is high, but not for reasons that make sense in terms of interest rates.  Inflation is high now because of supply shortages.  Still, the federal reserve board sounds like it will be increasing interest rates in the spring, which should cool down the stock market some, but also make your bank money worth more.  It is quite possible that interest rates could continue going up sometime in the next 15-30 years to the point where putting your money in a CD could net more than pre-paying your mortgage if you have a low interest rate loan.

If your interest rate is above 5%, then it makes more sense to pre-pay the mortgage because when you risk adjust things, the stock market isn’t likely to do as well as paying down the mortgage.

Mortgage companies can also provide some protection against insane HOA if you ever get into a bad situation where the HOA wants to take your house.

It is also really important to note that OMDG is maxing out their 529 and our tax advantaged retirement savings– you can always pre-pay a mortgage, but you get a limited amount of space for tax-advantaged retirement savings each year.  If I could go back, I would max out both our 457s back when we had them and not put any of that money in mortgage pre-payments or 529s.  (Being honest, I would probably still round up the mortgage payment to a round number for irrational psychological reasons, but that was never a huge sum.)

That said, there are some other things that could make it more attractive to pre-pay the mortgage.

  1.  Early pre-payments are worth more than later pre-payments because of how mortgages are structured.  They are not revolving debt.  You’re basically paying mostly interest with your regular payments at the beginning of the loan and mostly principal at the end of the loan.  Any pre-payments go directly to principal which can cut quite a bit out at the beginning.  I really like this GRS amortization spreadsheet for calculating what effect pre-payments will have on the lifetime of your loan.
  2. If you are expecting to get any sort of financial aid from colleges, it can make sense to turn taxable assets (like taxable stocks, but NOT retirement stocks) into home equity because they assume you will sell stocks to pay for college but not that you will sell your house.  That is, home equity is not generally included in college financial aid decisions.
  3. If you are EXTREMELY risk averse, or if having the money in stocks makes you more likely to spend it rather than save it and you want to save it, or if you have other emotional kinds of things dealing with not wanting debt.
  4. If you just want to not deal with the hassle of paying a bill every month (and if it’s less effort to pay property taxes once or twice a year instead of having the mortgage company handle that).

After we asked, you noted that your mortgage is 2.75% for 30 years.  With a mortgage rate that low, if your incomes are high enough to not qualify for financial aid, I’d probably just pay the minimum to the mortgage and not split the difference.  YMMV.  There’s not really a wrong answer, so long as you’re saving/investing the money in lower risk assets (stock market indexes aren’t low risk in the short term but they’re pretty good in the long term).

Grumpy Nation, how do you handle mortgage pre-payment vs investing?


31 Responses to “Ask the grumpies: The mortgage vs. stocks question (in a low interest rate, high inflation environment)”

  1. Foscavista Says:

    Just two things to add:

    1. There is a psychological benefit of paying off your home. The burden of having to work to pay down what is typically one’s largest debt melts away. We went from a we-must-both-work household to a we-could-live-off-one’s-income-if-we-wanted-too one.

    2. Before paying off your mortgage, see if you need/want to finance the purchase of something else (e.g., car, solar panels, etc.). While I had a mortgage my FICO score hit 850. Once I no longer had any monthly loan (not credit) payments, that factor brought down my score to the 825-ish range and has maintained it since. It’s still excellent, but just something to consider.

    • omdg Says:

      We are planning on renovating the existing master bath/BR and painting the interior (will be about 70K when all said and done). I do see new cars in our future since we have 2008 and a 2012 Subaru Foresters, but it’s hard to know when that will happen since both cars are currently running great (KNOCK ON WOOD), and we drive very little. But even if failure happens simultaneously and catastrophically, we would be able to put money down for new cars pretty easily, even though it would be a pain.

      I kind of love the idea of solar panels on the new house. Having a smaller carbon footprint and being less dependent on the grid seems like a worthwhile investment. N&M have you ever thought about doing this?

      We are also starting to have what… seems like a lot in our daughter’s 529. Any thoughts on what is “too much?” She’s 10.

      • nicoleandmaggie Says:

        We’re waiting to need a new roof before considering solar panels.

        If you click the 529 tag there’s thoughts on too much.

      • omdg Says:

        House just got a new roof last year (WOOHOO!!), so maybe we’d do this sooner rather than later? House does get sun (by MI standards). Am really curious about this.

      • nicoleandmaggie Says:

        Yes, sooner rather than later. Google has a thing that looks at your google map image and tells you if it will be worth it monetarily.

      • bookishbiker Says:

        Ooh that solar calculator (project sunroof) is great. I’d recently calculated my average monthly electric payment over my last 9 years, and it’s $35/month, so not really worth it to get solar panels from that perspective. I am considering them long-term for ecological reasons + fully expect to join the electric car revolution at some point in my life; at that point it may become a no-brainer.

      • teresa Says:

        We are in the middle of having a solar roof and backup batteries installed right now. As in currently the garage and maybe 30% of the house have solar tiles and the rest of the roof is still underlayment. We went with the tiles over panels mostly because we needed a new roof anyway and also honestly aesthetics. If you have a basically new roof then panels would obviously be the way to go. Plus you generally get more capacity for a given area with panels. We played with the google solar calculator as well as tesla’s (which I think actually uses google). We also got quotes for a few panel and battery configurations from EnergyPal (free); there are undoubtedly other places that’ll do that too.
        Also if you have panels installed and activated this year you still get a 26% tax credit (including 26% of the installation labor, any associated costs, and any batteries you get), no income ceiling- as of now it’s supposed to drop to 22% in 2023 and 10% in 2024 I think. CA also has state-level utility incentives for installing backup batteries – worth checking if MI does too.

  2. yetanotherpfblog Says:

    I paid extra to our mortgage the first couple years after we bought and honestly I really regret that decision. It would have made so much more in the market. Nowadays I don’t pay any extra and don’t plan to for the lifetime of the mortgage.

    Also, because you mention inflation, one very low risk way to make more than your mortgage interest rate is to throw what would have been a mortgage prepayment into I Bonds (currently ~7% rate over next six months).

    • nicoleandmaggie Says:

      wait, what? ~7% rate over next six months?!??! Why is the personal finance community not shouting this from the rooftops? Goodness gracious.

      • nicoleandmaggie Says:

        OMDG– do that! I-bonds are a safe asset and even if you just hold them for 5 years (the minimum to not get a penalty) and then pre-pay the mortgage you’ll still come out ahead most likely. (Do the numbers using the GRS spreadsheet to make sure. There’s still that funky amortization math. And you likely don’t currently have a large lump to throw at it because you just bought the house. But still, check it out as an alternative.)

      • yetanotherpfblog Says:

        Minor clarification on downsides: the rate changes every six months based on inflation. It can be as low as zero. But you can take the money out after a year with a penalty of 3 months interest and after 5 years with no penalty. You are also capped to $10k purchase of bonds per person per year.

        Still, in my opinion, a much better deal than paying down a 2.75% mortgage, at least right now.

      • nicoleandmaggie Says:

        Anything that’s a hedge against inflation right now is good since it’s not a normal kind of inflation that is proportional to interest rates. (Disclaimer, not a macroeconomist)

      • Revanche @ A Gai Shan Life Says:

        I’m pretty sure that I shared it but I didn’t shout it because you can only buy $10k per person and the Treasury Direct site is ABSOLUTELY HORRIBLE.
        I have to write it up I guess but I lost access to my account since I hadn’t logged in for 7ish years and it’s quite impossible to get it back.

      • nicoleandmaggie Says:

        That sounds really irritating. :(

      • Debbie M Says:

        If you’re getting a big enough tax refund, you can designate that some of it be returned to you as iBonds–that’s not as messy as the site.

      • yetanotherpfblog Says:

        +1 to what Revanche said. The Treasury Direct site is laughably terrible. You literally have to enter your password by “typing” with your mouse on a keyboard displayed on screen. It’s… something else.

  3. Henry Says:

    I completely agree with what others have written. Financially, it is almost certain at 2.75% interest that you will be significantly better off in the long run by not prepaying the mortgage. And that goes double if the alternative is putting more money into tax advantaged accounts.

    One point worth making explicit is that pre-paying the mortgage should be compared to holding bonds (or CDs or other safe-ish investments), not stocks. Putting money into the mortgage is more like buying bonds which pay 2.75% (or whatever) than it is like buying the volatility and risk of the stock market. Also, you should layer on the fact that prepaying your mortgage locks funds up in the house and they are no longer available for emergencies, etc. So it’s something like a CD where you can’t withdraw the money. Right now I-bonds beat the pants off of putting money into the mortgage. A better rate and (after a year) all the liquidity you could want.

    But finance is personal, too. So if locking up the money keeps you from squandering it, or if having a paid-off house brings peace of mind, then that can offset the purely financial aspects. Many people split the difference like you are doing. That is very reasonable if that’s what you’re comfortable with. A good plan you can comfortably execute is better than one which might look good on paper, but doesn’t work for you.

  4. Alice Says:

    As another thing to consider– I’ve been looking into recasting our mortgage. Pre-pandemic, I was by far the breadwinner. I’m self-employed, though, and the childcare situation has resulted in my income dropping to less than half of what it was before. We’re able to get along as we are, but I would like our monthly recurring expenses to drop for my own peace of mind.

    Since you bought recently, maybe consider saving now and working towards a recast down the line?

  5. Revanche @ A Gai Shan Life Says:

    I prepaid a large chunk of our mortgage in the first two years for a couple reasons: the lowered principal benefit of early prepayment and wanting a lower monthly payment. I recast it three(?) times, and that was pretty simple and it got our payment down to a manageable level. I know I could have just paid it out of savings monthly but I preferred to take the path that gave us some longer term savings too.

    Now I’m almost sure that we would have made more money in the market between then and now BUT easing the strain on our monthly cash flow was important.

  6. Jenny F. Scientist Says:

    Our mortgage is financed by our mutual employer at a ludicrously low rate, and our investments all make more interest than that, so we don’t prepay. We also don’t have to pay any kind of mortgage insurance or other fees, and we did the calculations and it’s not worth it to pay it off early. (We also had a down payment of about 25%.)

  7. Debbie M Says:

    First, to illustrate point #1 about early payments being more valuable, when I got my mortgage in the dark ages, only $30 of my $505/month P&I payment was going toward principal. That meant that paying an extra $100/month was covering more than three months of payments, and thus cutting three months off the end of the mortgage. That makes for a pretty exciting graph (minimum payment versus actual payment), if you’re into those things.

    I pre-paid at first until I refinanced to a lower rate. Then I decided I could get a better return in the market. It turns out those 15 years saw no net change in the market, so this was not as good a plan as I expected it to be, but then that money all went into a Roth IRA, so it was still the right decision.

    And as Jenny implied, if you’re paying private mortgage insurance, paying down the mortgage until you have 20% equity can let you cancel the PMI sooner.

    • middle_class Says:

      We made several extra payments toward mortagage in the first five years. Then we paid it off entirely due to inheritance. We could have probably made more if we invested but my spouse is very risk adverse.

      Peace of mind is worth it. I figure if we really really needed funds we could take a loan on our house.

  8. bookishbiker Says:

    wooooooooow – I’d bought an I-bond last year after Revanche mentioned them, but I just now initiated moving some of my emergency fund out of a money market account and into an I-bond instead. It’s been sitting untouched for 5+ years, and I have access to other money if I need it, so seems like a prime candidate for the bond fund. It’s okay that it’s locked up for the first year.

    • bookishbiker Says:

      Well, I meant for that comment to be higher up in the I-bond thread, of course. oops.

      A far as the original question, there are lots of options and you’re allowed to change your mind over time!

      I’ve changed course several times over the last 9 years:
      – started out setting aside money and investing it, planning to let it pile up and then one day cash out to pay off the mortgage.
      – that wasn’t very satisfying, and there is the factor that you pay more interest in the beginning of a mortgage, so I swapped to paying ahead on the principal
      – then I decided to stop that (since my mortgage is not very onerous) and instead set aside that money in a retirement bridge fund
      – which may actually become a self-funded sabbatical instead.

      Money = flexibility, so that’s an argument for setting it aside, but it sounds like you’re in okay shape on the savings front, in which case I’d personally go with paying down the principal.

  9. First Gen American Says:

    I’m old enough to have lived through at least one “lost decade” when it came to investment growth and I’m not 50 yet. (After the bubble burst) and witnessed 1/2 my savings evaporate during the 2008 crash. I was young when it happened so not the end of the world, but would it still be okay if you made nothing for the next 10 years but then made huge gains after that?

    Right after the 2008 stock market crash, my company also had massive layoffs to the tune of 40% of our department being let go. I got extremely lucky and wasn’t laid off but I was kicking myself for not having a paid off house then.

    I guess if your time horizon is long enough, it doesn’t matter but I wouldn’t count on every crash being as short lived as the one back in 2020. Everyone with a Robin Hood account is walking around thinking they are geniuses, but they just aren’t old enough yet to have had to lived through a sustained economic downturn.

    Here’s another way to look at it. If you won your house and it was paid off, would you then go out mortgage 80% of the equity and invest it? If not, what % would you invest?

    I just needed more sure things in my life. A liquid emergency fund and a lower cost of living (by eliminating our mortgage) were things I could absolutely count on during the pandemic even though they weren’t the “best” investments. It was a much less stressful experience this time around despite how crazy life was during the last 2 years. Piece of mind is worth more to some than others.

    • omdg Says:

      I’ve lived through 1) my parents being repeatedly laid off their jobs during my childhood, 2) recession #1 in 2000, 3) recession #2 in 2008, 4) recession #3 in 2011. Yes we are on a big ole stock market upswing right now, but I am kind of gun shy given what I’ve seen happen over and over in my family. We bought a cheap enough house that we could pay the mortgage on only one income because I have exactly zero faith in my (or my husband’s) employers, the stock market, or the housing market. And yes, I know “things are different this time” and now we have protections in place so that those things won’t happen again. Isn’t that what people always say right before they get effed in the butt? I also worry about what would happen if I needed to find a new job. Husband can work remote, and in theory I could too (especially if I left medicine). But if I wanted to continue practicing medicine I’d probably have to move, or at very least drive A LOT more than I currently do on a day-to-day basis, which is extremely unappealing.

      • nicoleandmaggie Says:

        In the long run, we expect the stock market to increase about 5% real, give or take (7% nominal, but more if inflation is higher). 30 years is the long run! If you’re talking about short term savings, neither the stock market nor pre-paying a 30 year mortgage are the “right” choice (though you can get some of the mortgage back through recasting, as noted, it’s still only a part compared to other safe investments that are more liquid). Yes, you can get some amount back from selling your house, but there’s no guarantee that housing will appreciate or depreciate any differently than stocks do, and you don’t have to wait for someone else to buy stocks– you can always sell them at the price the market sets.

  10. Jen Says:

    We chose a 10 year mortgage instead of a 30 (essentially choosing a mandatory pre-payment) as part of our college savings plan. We didn’t want to lock things up in a 529 for various reasons so a shorter mortgage gives us a paid off house the year our oldest goes to college. That, along with other monthly savings, will allow us to cash flow college. Since the 529 would get less risky the closer they get to college, it’s not much of a difference in hypothetical earnings

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