Spend or Save: Should I Pay Off My Mortgage, or Invest for Retirement?

Trying to decide between eliminating debt and investing for the future is a difficult decision. For many families, 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?

Paying Down Your Mortgage First

Let's say you’re finally in the home stretch with a mortgage you took out years ago. It’s been a long haul, and you’re tempted to pay it off in one final payment and finally be free and clear—or, at least, accelerate your payments a little to be done sooner.

While it may seem tempting to pay down your mortgage near the end, it’s actually better to do so at the beginning. Although you make the same size payment each month (assuming you have the proverbial 30-year fixed-rate mortgage), most of your money in those early years is going toward interest and doing little to reduce the loan's principal.

So by making extra payments early on—and reducing the principal on which you're being charged interest—you could pay considerably less in interest over the life of the loan. The same principles of compound interest that apply to your investments also apply to your debts, so by paying down more of your principal early, the savings are compounded over time.

By contrast, in the later years, your payments are going more toward the loan principal. Paying more won’t reduce your total interest burden as quickly; it’ll just build your equity in the home faster (and shorten the loan term overall). Not that there’s anything wrong with that, but we’re looking for the best uses for your money.

Paying Down Your Mortgage Example

So let’s assume it’s still the early days for your mortgage—within the first decade. 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 is not the worst idea in the world. But mortgage interest is not the same as other types of debt. It’s tax-deductible if you itemize deductions on your income tax return. In 2022, you can deduct home mortgage interest on the first $750,000 of a loan secured by your home ($375,000 if married filing separately). For home mortgage debt incurred before Dec. 16, 2017, you can deduct home mortgage interest on the first $1 million of indebtedness ($500,000 if married filing separately).

If you need something to reduce the amount you owe Uncle Sam, the mortgage might be worth keeping.

If you have an adjustable-rate or other non-standard mortgage, paying down the mortgage—even if it’s later in the game when you’re paying off a greater portion of 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 if you ever decide to.

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 a way to keep from going underwater (owing more than your home is worth). That could make it difficult for you to sell the home, refinance it, or obtain other credit.

Funding Your Retirement First

Unfortunately, while it’s better to pay a mortgage off, or down, earlier, it’s also better to start saving for retirement earlier. Thanks to the joys of compound interest, a dollar you invest today has more value than a dollar you invest five or 10 years from now. That's because it will be earning interest—and the interest will be earning interest—for a longer period of time. So each year you delay saving for retirement will hurt you a disproportionate amount.

For that reason, it generally makes more sense to save for retirement at a younger age than it does to pay down a mortgage sooner. You can estimate your retirement savings with the U.S. Social Security Administration's calculator.

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.

Extra Mortgage Payments vs. Investing

Assume you have a 30-year mortgage of $150,000 with a fixed 4.5% interest rate. You'll pay $123,609 in interest 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 about $98,000—$52,000 ahead of the sum you saved in interest—on the funds you contributed. Keep depositing that monthly $188, though, for 10 more years, and you’d end up with almost $230,000 in earnings.

So while it may not make a huge difference over the short term, over the long term, you’ll likely come out far ahead by investing in your retirement account.

Compromise Position: Funding Both at Once

Between these two options lies a compromise—fund your retirement savings while making small additional contributions toward paying down your mortgage. This can be an especially attractive option in the early phases of the mortgage when small contributions can reduce the interest you'll ultimately pay. Or, if the market is being extremely volatile or spiraling downward, it might make more sense to pay down your mortgage instead of risking the loss of 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 run 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. For example, if your mortgage interest rate is far above what you can reasonably expect to earn, getting rid of it can be advantageous (and vice versa if you're paying a relatively low rate of interest ). Also, if you have an unusually high interest rate on your mortgage, it makes financial sense to pay down the debt first—or look into refinancing.

The Bottom Line

Paying a mortgage off, or down, early is a great thing to be able to do. Starting early on saving for retirement is also great for your finances and your sense of well-being. The money you spend paying off your mortgage won't be compounding, and the rate at which it grows in an IRA or index fund will be greater than your rate of interest on your mortgage.