The thought of owing perhaps hundreds of thousands of dollars on your mortgage can be daunting.
High-interest debt (credit cards, payday loans, personal loans) is a real problem for a lot of Americans. So, for those of you who strive to be financially responsible, you’ve probably been conditioned to have an aversion to debt of any kind.
To borrow a line from Sesame Street, though, one of these things is not like the other. There's a difference between paying 21.6% interest on a credit card — the current national average — and less than 3% on a mortgage you locked in or refinanced when interest rates sat at all-time lows.
If you’ve got a great interest rate on a mortgage, should you be obsessive about paying it down with every extra penny? Or should you pay the minimum and put the extra money to work elsewhere?
That's what a listener of the Clark Howard Podcast recently asked.
Should I Invest or Pay Down My Low-Interest Mortgage?
Should I invest or pay extra on my mortgage? That's what a Clark listener wondered on the Jan. 11 podcast episode.
Michael in Illinois asked: "I have a 2.25% home mortgage rate. I have been paying quite a bit in extra principal to try and pay off the mortgage sooner. Is this wise? Would that 'extra' money be better off invested in the market?"
Clark did not hesitate to tell Michael to make only the minimum payments on his mortgage.
“So Michael, to tell somebody not to end up mortgage debt free is a terrible thing for me to say. But in your case, your mortgage interest rate is so low that [you should] pay the mortgage as agreed,” Clark said. “Because even in a simple savings accout, you can out-earn 2.25%.”
The decision is simple math. Let’s assume you can make your minimum mortgage payments and that you consistently have extra cash. If you can earn more on your extra cash than you’re paying in interest on your mortgage, do it.
You don't want to get into a position where you're leaving yourself no margin for error. For example, let's say you have a minimal emergency fund and you're piling every extra dollar into a retirement account with steep penalties for early withdrawal. What happens if you get laid off from your job?
But beyond putting yourself into a potentially tight situation, there’s otherwise little reason to pay down your mortgage first “just because.”
Mortgage Rates vs. Other Money-Making Opportunities
Many people bought houses or refinanced their mortgages between March 18, 2008, and Sept. 27, 2018, or from Sept. 19, 2019, to July 27, 2022, when the national interest rate sat at 2% or less — and often well below 1%.
Mortgage rates below 3% were commonplace during that time period. Especially on 15-year mortgages for people with good credit.
“Generally, the point at which it’s not as good of an idea to prepay a mortgage is when [your mortgage rate] is below 4% in today’s marketplace,” Clark says.
“The stock market has been depressed. It may go down more. Who can predict in the short term? But long-term, values are at a much more reasonable place.”
Right now, you can earn 4.5% on five-year CDs. The best savings accounts are yielding in the neighborhood of 3.5% APY. Heck, Series I savings bonds are still paying 6.89%.
That’s not even mentioning the long-term return you can expect if you invest in the stock market.
The S&P 500 averaged a 10.4% annual gain in the last 15 years. And that's an arbitrary block of time that starts with a 38.5% loss in 2008 and ends with a 19.4% loss last year. That annual return dwarfs the 2.25% interest on Michael's mortgage.
"I'd rather see you take that money you're prepaying on that mortgage, open a Roth IRA and put it in a target retirement fund [at] Vanguard, Schwab or Fidelity," Clark says.
Final Thoughts
If you land an average 30-year mortgage today, you’re paying 6.4% interest.
However, many people who bought or refinanced in the last 15 years are paying less than half that amount of interest.
If your mortgage rate hovers below 4%, Clark says, consider paying only the minimums and investing — or at least looking into high-yield CDs or other interest-beating options.
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