This post is for a friend who asked me to punch some numbers to figure out what makes more financial sense: accelerated mortgage payments or minimum mortgage payments supplemented with investing. Let’s explore what might make more financial sense.

## To Mortgage or To Invest?

What makes more financial sense? To make accelerated mortgage payments or to make the minimum payments and invest the difference? What will net you more money in the end?

Let’s make some assumptions for our mortgage calculation:

I’m using these figures because I assume they are in the ballpark of what my friend is looking at. The rate I am using is the lowest 5-Year Fixed rate I could find on RateHub. The numbers in the table above were calculated over at RateHub.

We will ignore other fees associated with purchasing a home – such as taxes, land transfer, lawyers, realtors, etc – in order to keep this as simple as possible. We will also assume a static interest rate, just to keep things simple.

Remember, the calculations we are going to make are approximates, rules of thumb. To figure out a specific, unique situation would require specific, unique data. And even with specific, unique data, it is still very hard to calculate anything but approximations because of changing interest rates, changing rates of inflation, and a myriad of other volatile factors.

## To Mortgage

This is what the mortgage looks like if you pay the minimum amount over the lifetime of the mortgage:

This is what the mortgage looks like if you make the additional 20% payment ($233) every month:

These are the differences between the minimum payments with no additional payments and with additional payments:

So over the lifetime of the two mortgages, paying the additional monthly payments will allow you to finish your mortgage 6 years sooner with $27,786 less in interest paid.

The numbers above were calculated using this mortgage calculator and this mortgage calculator.

Now, let’s see whether it is financially advantageous to invest that money instead.

## To Invest

Now, let’s make some investment assumptions:

Why the TD E-Series US Index Fund? Because it tracks the S&P 500 index.

If you look at the historic returns of the S&P 500 from 1871 to 2012, the average annual return was 8.92%. Over the very long term, the stock market undeniably returns a positive rate of return. Over the very long term, the stock market returns an inflation adjusted return of 6% to 7%.

For our thought experiment, we will lower our expectations from the historic rate of return of 8.92% to 6%. We will expect our returns to average 6% over 25 years.

Again, for simplicity’s sake, we will ignore fees and volatile factors, such as inflation.

If you invest $233 every month for 25 years at a 6% average rate of return, this is what it looks like:

Pretty impressive stuff. And it obviously is a much more impressive total than the $27,786 you would save by making the extra mortgage payments.

But is it that simple?

## A Hybrid Approach

What about a hybrid approach? What if we made the additional monthly mortgage payments, paid the home off in 19 years, and then invested $1400 every month for 6 years? This is what that looks like:

It seems close, but not as impressive as the invest option. This is a chart of our 3 different scenarios:

And with a shorter investment window – 6 years instead of 25 – the returns on the investment could vary wildly depending on whether we were in a bull market or a bear market. There is increased risk to volatility with such a smaller investing window.

## Conclusions

What conclusions, if any, can we come to from this little thought experiment we ran?

Well, this was a very rough estimate on a single scenario with fixed variables. There are a myriad of variables we did not take into account for simplicity’s sake. This is a very, very rough rule of thumb for a single scenario.

That being said, I believe there are lessons we can draw from this.

First, with historically low interest rates, it is possible to pay the minimum on a mortgage and take the difference you would pay towards additional mortgage prepayments and just invest it in a broad based mutual index fund. This option would not exist with higher interest rates. Why? Go play with this calculator to find out yourself.

Second, the numbers presented here demonstrate the power of compounding and the power of the stock markets as powerful wealth generating factors. Time and consistent savings/investing can yield amazing results.

Third, this posts demonstrates the different options that exist when it comes to paying off your mortgage.

## Final Opinion

It’s my opinion that for the majority of people, it is probably prudent and wise just to focus on paying off their mortgage – either through minimum payments or accelerated payments – because it acts as a forced savings program. For those who aren’t the savviest with their money, a mortgage is a forced savings program and it is better to be paying off the home and building equity rather than not.

However, for those who understand financial concepts better, are stringent savers, and won’t panic because of market volatility, the potential gains of thinking outside the “forced savings box” could yield immense financial benefits.

Is there anything I am missing with my calculations? How do you pay your mortgage and invest?

Simple clear math, well explained and nice graphs. As you stated this is not a discussion on the cost of home ownership but rather on how you can take advantage of terrific low mortgage rates and choose to invest instead. There is also a second upside dependng on your financial situation, in Canada that near $2800 a year adds up to a nice RRSP deduction if that is how you just to invest in the index fund. Once again, great post.

Thanks Chris! Like you stated, I think there are great investing opportunities with such low interest rates. It’s not for everyone though, as you could just as easily lose money with foolish market moves if you don’t have the knowledge, temperament, and risk profile for investing in the market.

The math definitely shows what you should do, but as you stated – a house is a forced-savings plan for a lot of people. I think I’d probably find a middle-ground to pay it off a bit faster, but also still put at least a bit aside for investments.

Good analysis Steve!

Thanks Alicia! I think the hybrid option might be good for those who might not fully be comfortable with investing while holding a huge liability such as a mortgage!

Nice comparison š I wrote a related article about this topic last year on Feb 26th. I basically came to the same conclusion lol. And yeah, it’s ridiculous how many different variables can go into the calculation to shift the final results in one direction or another. I’m personally in the camp of making minimum mortgage payments while investing as much as possible, but I understand that a lot can change during a long amortization period š One thing I sometimes remind people is that by making the minimum mortgage payments and investing the savings will still put equity in their homes, but it will help to diversify their financial assets so they aren’t 100% exposed to just one asset class, real estate š But for people who are just going to spend any excess savings instead of investing, then it’s better for them to just accelerate their mortgage payments lol.

I actually didn’t think about the diversification aspect of investing and mortgage š

What would your opinion be if interest rates spiked up to 5, 6, 7, or even 10%??

I revise my optimal capital structure quarterly. My mortgage rate is currently 2.6% so I don’t mind holding onto it for now. But if interest rates start to rise then I will allocate more savings towards paying off my debts š If rates rise to 5% or 6% I will probably pay off an extra $1,000 of debt per month. At 8% borrowing cost I will probably be in 100% debt repayment mode and stop investing all together. At 10% and higher I may even sell some stocks or ETFs to de-leverage, and pay off the higher interest loans.

Thanks for your take and insight on how rising interest rates would affect your mortgage vs. investing decision making š

It’s always nice to see other people’s perspectives!

Ahhh, the eternal battle. Most people are polarized about this, but I think you nailed it in your conclusion. I’m firmly on the “investment” side of this battle, this also acknowledge that this just isn’t right for everyone.

I strongly believe rates will go up in the next couple of years as the global economies continue to heal and we return to normal. A 7% rate would put me in firmly into the “plow money into the mortgage” camp.

Thanks for the comment Mr. 1500! You answered the question I posed to Liquid with your personal take on the scenario if interest rates rose above 5%.

Really enjoy your writing over at your blog, thanks for stopping by š

Currently I’m doing both – investing and overpaying my mortgage. I’m pretty sure it’s simply because that’s the happy medium in my eyes. But the other thing I’m trying to do is to build up the equity in my home and when my mortgage comes for renewal to start using it for investing through Smith Maneuver scenario.

Covering all the bases, I guess:)

I like it. I think the key is to have a well thought out plan. Rather than aimlessly and mindlessly paying a mortgage, figuring out what works in your scenario and what makes sense and implementing your plan.

I remember reading a little bit up on the Smith Maneuver but I’ll have to go brush up on it again!