Why Keeping Your Low-Interest Mortgage Could Be Your Most Efficient Wealth-Building Tool

 


With mortgage rates hovering below 6%, many homeowners are reevaluating whether it makes sense to pay off their mortgage early or invest their extra cash elsewhere. While the idea of being debt-free is emotionally appealing, the numbers often tell a different story. Here’s why holding onto your mortgage and investing in low-cost index funds could be a more efficient financial strategy.

The Cost of Debt vs. the Return on Investment

A mortgage with a sub-6% interest rate is relatively cheap money, especially when compared to historical averages. In contrast, the stock market, represented by the S&P 500, has delivered an average annual return of around 10% before inflation over the long term. Additionally, small-cap value stocks have historically outpaced the S&P 500, delivering average annual returns closer to 12-13%. Even after adjusting for inflation and taxes, the after-tax return on investments, particularly in small-cap value stocks, often outpaces the after-tax cost of a mortgage.

Example: If you have a $200,000 mortgage at 5% interest and choose to invest an equivalent amount in an index fund averaging 8% annual returns, your investment will likely grow faster than the amount you save by paying off the mortgage early.

Tax Benefits of a Mortgage

Mortgage interest can be tax-deductible if you itemize deductions. While the 2017 Tax Cuts and Jobs Act raised the standard deduction, limiting the applicability of this benefit for some, it still adds value for those with higher mortgage balances. Lowering your taxable income further reduces the effective cost of carrying a mortgage.

The Power of Liquidity

Paying off your mortgage early ties up significant capital in an illiquid asset—your home. Keeping your money invested instead allows for greater flexibility. Should you need funds for an emergency, investment opportunities, or unforeseen expenses, it’s much easier to sell a portion of your investments than to tap into home equity.

Diversification of Assets

Allocating money to investments rather than exclusively focusing on debt repayment helps you diversify your assets. A paid-off home represents a concentrated position in real estate, while investments in index funds provide exposure to a broader array of industries and asset classes, spreading your risk.

Behavioral Considerations

Investing instead of paying down a mortgage requires discipline. The key to making this strategy work is consistently investing the difference rather than spending it. Automating your investments can help ensure you stay on track.

A Mortgage as an Inflation Hedge in Retirement

Carrying a mortgage into retirement can serve as a powerful inflation hedge. Fixed-rate mortgage payments remain constant over time, even as inflation causes the value of money to decrease. This means that as the cost of living rises, your mortgage payment becomes relatively less expensive in real terms. Meanwhile, investments in equities or other inflation-protected assets can grow to outpace inflation, further enhancing your financial position. This combination allows retirees to manage cash flow more effectively and maintain purchasing power over the long term.

When Paying Off Your Mortgage Early Might Make Sense

While investing often wins out mathematically, there are scenarios where paying off your mortgage early can be beneficial:

  • You have a low risk tolerance and prioritize peace of mind over potential returns.

  • Your mortgage interest rate is high, and refinancing isn’t an option.

Final Thoughts

The decision between paying off a low-interest mortgage and investing is highly personal and depends on your financial goals, risk tolerance, and market conditions. For many, leveraging the relatively low cost of mortgage debt to invest in high-return assets like index funds is a powerful way to build wealth over time. However, ensuring you’re comfortable with the risks and committed to a disciplined investment strategy is essential to make this approach work.

Not Paying Off a Low-Interest Mortgage Can Be a Smart Financial Move

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