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Quick Summary

  • There’s no one answer as to whether it’s better to pay down a mortgage or to save for retirement. In each case, you have to crunch your own numbers.
  • In general, if you’re going to pay down a mortgage, it’s better to do so within the first 10 years, when most of your payments go towards interest.
  • Starting retirement savings early is important, to reap the benefits of compounded interest and exponential growth of investments.
  • For younger people, prioritizing savings often makes more sense than accelerating mortgage payoffs.

 

I have a saying: “If someone asks you if you want one thing or another, always choose both.” Unfortunately, as tempting as it sounds, that’s not always an option when it comes to your hard-earned funds. Case in point: trying to decide between two equally pressing priorities—eliminating debt and investing for the future. Between not wasting money on interest payments, and making money work for you, in other words.

For many a family, this choice often comes in the form of paying down their mortgage (the biggest debt they’ll probably ever have) or saving for retirement. Both are laudable goals, but which should come first? Let’s examine the benefits and drawbacks of each strategy.

Paying Down the Mortgage First

It’s been a long haul, but you’re finally in the home stretch of your home mortgage term—and you’re so tempted to pay the thing off in one gulp and finally be free and clear. Or, at least, accelerate those payments a little to be done sooner.

While it can be tempting to pay down your mortgage towards the end, it’s actually better to do so at the beginning. Although you seem to be making the same size payment each month (assuming you have the proverbial 30-year fixed-rate mortgage), most of your payments are going toward interest and not the loan principal in those early years. So by paying as much as you can right away, you can pay less in interest overall.

In contrast, in the later years, your payments are going more towards the loan principal. Paying more won’t reduce your payments, it’ll just build your equity in the house faster (and shorten the loan term overall). Not that there’s anything wrong with that. But we’re looking for the best uses of your money.

OK, let’s assume it’s still early days for your mortgage—within the first decade of it. Let’s say you have a 30-year fixed $200,000 loan at a 4.38% rate; that amounts to a lifetime interest charge of $159,485 if you pay the usual 12 times a year. Make that a lucky 13 payments each year, though, and you save $27,216 in interest overall. If you kicked in an extra $200 each month, you’d save $6,000 in 10 years, $50,745 in 22½ years—and you’d have the mortgage paid off, too.

Other Mortgage Considerations

Saving money on interest: not the worst idea in the world. But mortgage interest is not the same as other debt. It’s tax-deductible if you itemize deductions on your income tax return. You can deduct up to $750,000 of mortgage debt in 2019. If you need something to reduce the amount you owe Uncle Sam, the mortgage might be worth keeping.

Fast Fact: About one-third of U.S. households have a mortgage; the average debt is approximately $168,000.

For those with adjustable-rate or other non-standard mortgages, paying down the mortgage—even if it’s later in the game when you’re paying off principal—can be an advantage. Building equity in a home that is financed by an adjustable-rate loan will make it easier for you to refinance to a fixed-rate mortgage.

Also, if local real estate values are tanking, if people in your area are seeing little appreciation, or even depreciation in their homes, paying down a mortgage is an especially good way to keep from going underwater (owing more than your home is worth).

Funding Retirement First

Unfortunately, while it’s better to pay off or down a mortgage earlier, it’s also better to start saving for retirement earlier too. Thanks to the joys of compounded interest—the type of interest your money is earning for you this time—investments gain value exponentially. In other words, a dollar invested now has more value than the dollar you’ll invest five or 10 years from now. So each year you delay saving for retirement will hurt you a disproportionate amount, because you’re losing not just the sum of money, but the earning power of that money.

Therefore, it makes more sense to save for retirement at a younger age than it does to pay down a mortgage. The earlier you start, the more time you have to enjoy compound growth, and eventually your retirement account might fund itself.

Of course, investments don’t just rise; they fall too, and their performance can fluctuate wildly with the financial markets. The returns, alas, aren’t usually as fixed as mortgage payments are. But that’s all the more reason to start investing sooner rather than later: Your portfolio has more time to recover from roller-coaster behavior by the market. And the stock market has historically risen over the long term.

Comparing Mortgage Paying vs. Investing

Assume you have a 30-year mortgage of $150,000 with a fixed 4.5% interest rate. That equals $123,609 over the life of the loan, assuming you make only the minimum payment of $760 each month. Pay $948 a month—$188 more—and you’ll pay off the mortgage in 20 years, and you’d save $46,000 in interest.

Now, let’s say you invested that extra $188 every month instead, and you averaged a 7% annual return. In 20 years, you’d have earned $51,000—$5,000 ahead of the sum you saved in interest—atop the funds you contributed. Keep on depositing that monthly $188, though, for 10 more years, and you’d end up with $153,420 in earnings.

Basically, you can save just about the same or even more money in the short term by paying down your mortgage faster. In the long term, however, you’ll likely come out far ahead by investing in a tax-advantaged retirement account.

Pros and Cons of Paying Down Mortgage

Pros

  • Pay less in interest
  • Build home equity faster
  • Shorten loan term

Cons

  • Lose tax deduction on interest
  • Less money to invest

 

Pros and Cons of Saving For Retirement

Pros

  • Earn a better rate of return
  • Keep assets liquid

Cons

  • Incur market risk
  • Doesn’t help with debt

 

Funding Both at Once

Between these two options lies a compromise: Fund your retirement savings while making small additional contributions towards paying down a mortgage. This can be an especially attractive option in the early phases of the mortgage when small contributions can reduce the interest paid. Or, if the market is being extremely volatile or spiral downward, it might make more sense to pay down your mortgage instead of risking losing investment funds.

Since individual circumstances vary widely, there’s no one answer as to whether it’s better to pay down a mortgage or to save for retirement. In each case, you have to crunch your own numbers. Overall, however, don’t sacrifice the long-term savings goals of your retirement plan by focusing too much on your mortgage. By prioritizing your retirement-savings goals first, you can then decide if any additional savings are best spent on further contributions to your mortgage or on other investments.

In fact, you should balance paying down a mortgage against the return prospects of other, non-retirement savings options, too. For example, if your mortgage interest rate is far above what you can reasonably expect to earn, getting rid of it can be advantageous. Also, if you have an unusually high interest rate on your mortgage, then it makes financial sense to pay down the debt first—or look into refinancing.

 

Jason D. Steele is personal finance writer and a consumer advocate. He specializes in helping people eliminate credit card debt and maximize rewards.

 

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