Invest More or Pay Down the Mortgage? // What To Do With Extra Funds

Before we jump in on today’s topic, a few quick notes. First, some changes are coming to ONL, one of which you may have already noticed: capital letters. I wanted to keep the blog all lowercase to contrast this writing with my work writing, and because lowercase letters just feel more calm to me. But, we heard you loud and clear on the reader survey, and we’re going with normal sentence case from now on, to make things as readable as possible. Second, we’re considering shifting to a Monday-Thursday posting schedule instead of the current Monday-Wednesday-sometimes Friday schedule. We’d love your thoughts on what you’d like better — let us know in the comments! And finally, in case you missed it on Twitter yesterday, we revealed a photo of us with nothing covering our faces!

Haha! (Though while we’re on the subject, you can follow us on Twitter and Instagram, where we chat it up with lots of you and often share things that never make it onto the blog. We’re not super active on Facebook, but you can like us there as well if you feel like it.) ;-) And now, on to today’s topic…

A tension we notice a lot in PF blogland is the question of whether to prepay the mortgage, or sink as much money as possible into market funds, and it’s a question we struggle with, too. In some imaginary world in which we could see into the future and see how the markets will perform, it would be an easy decision to make.

If we just assume historical averages for market returns, it should become a pretty simple question:

Which is greater: the mortgage interest rate or the expected market returns? Put extra money against whichever wins.

But even that’s not an easy question, because it is based on a total guess about market returns, and it ignores opportunity cost, and maybe this just happens to be the time to load up on cheap shares before the market takes off in a few years. Or not. But essentially, it’s kinda hard to do the math on something when you don’t know what the variables equal.

In the absence of a psychic who can tell us these answers, and generally not being the types to try to time the markets, we ask ourselves different questions:

• What will get us closest to our goals?
• What will feel best?
• What will most reinforce positive financial habits?

Prefacing all of this with the assumption (and the truth in our case) that we’re already maxing out our available retirement accounts, we’re already saving a bunch in the markets and paying off our mortgage on time each month, and we’re not dealing with any high-interest debt, and so this question only pertains to the “gravy” money, let’s dive into those questions.

What gets us closest to our goals?

Our primary goal is to retire in 22 months, with a fully paid off house, and a magic number set aside in our Vanguard index fund and cash accounts. To achieve that, we have to put approximately $2 into our investment accounts for every $1 we pay against the mortgage. Our monthly mortgage payment and automatic Vanguard transfers roughly follow this ratio, also accounting for the property tax and interest that are included in our mortgage payment.

Why do we want a paid off house when we retire? We know there are lots of bloggers who would disagree with this basic premise that we should retire with our house paid off. We have three reasons:

1. We want to feel totally free. Not beholden to an employer, and not beholden to any banks.
2. We want to minimize the amount we need to save, and if we had to build a mortgage payment into however many years of our retirement, that would mean having to save more, possibly by working longer. No thank you!
3. Perhaps the most important part of the equation: We want to minimize our income each year, to maximize our Obamacare subsidy. If we had to have enough income to cover a house payment, that would push us into the small subsidy zone, and if we are going to take the subsidy in the first place, then we want to get our health care costs as low as possible.

So back to the goal question, the logical answer would be to follow the ratio that we need to hit: $2 invested for every $1 against the mortgage. But is logic the only factor we should weigh?

What will feel best?

We’ve written before, back in our blog infancy, about making decisions based on what’s best for your soul, not just what’s best on paper, and the mortgage vs. investments question goes right to the heart of that question. Because while you have a guaranteed return of your interest rate when you pay extra against your mortgage, it’s usually a pretty low rate. Whereas, with investments, you have the risk of volatility (a nice way of saying “the real possibility that you could lose money, especially in the short term”), but you also have the chance of a much, much higher return than you’ll get on your mortgage prepayment. But of course it’s not guaranteed. This is not a scientific conclusion by any means, but it sure feels to us like those who argue against prepaying a mortgage also like to take bigger investment risks — they want the thrill of the big win. And that’s cool (if that’s even true — again, not scientific), but we’d rather take a guaranteed return in most cases than the chance of a slightly bigger return.

And there’s something else — it feels bloody good to get rid of debt. Let’s not discount this factor. Anyone who has paid off credit card debt, or student debt or a car loan knows how incredible it feels to make that last payment and feel that weight lift off your shoulders. It only dawned on us recently, like literally last week, that there will come a time very soon when we do not pay anything to anyone on the first of the month to have a roof over our heads. No rent check, no mortgage autodraft. Just utilities and twice-annual property tax. Somehow, in all this planning, we had never thought about how that will actually feel. We’ll have to invent some sort of “first of the month dance” that we do in celebration every time the first rolls around and we don’t pay anyone anything to live in our house.

So even though our mortgage doesn’t feel like “bad debt,” it’s still money we owe to someone else, and there would be a real value to paying it off sooner rather than later in terms of how that would make us feel. We’ve seen some bloggers who’ve blogged about their debt payoff journeys lose steam when they transitioned from debt payoff to savings — it could be that there’s something inherently more satisfying about eliminating debt than saving money. Or maybe it’s just a coincidence.

What will most reinforce positive financial habits?

We’re on the verge of a big mortgage balance milestone — we’re about to drop below a meaningful number, and sometimes we talk about paying extra against the mortgage just to see that drop. That would feel like more momentum, which would reinforce what we’re doing. But then again, we like seeing our investment accounts go up in balance, and we all know the markets themselves aren’t any help on that front lately. We need a high savings rate to make sure we see any actual growth in our funds. But right now, with the markets all bajiggity, if we pay extra against the mortgage, that’s a guaranteed boost to our net worth. If we sink more money into our investment accounts, it’s a coin flip about whether we’ll actually see that money reflected in the short term in our balance sheet. (That’s not a reason not to save — we’re talking about the gravy money, on top of the big percent we’re already saving each month.) We’re so motivated to get to early retirement in strong financial shape, that we see any money going against the mortgage or invested in our taxable accounts as money well spent, but it’s still a question worth asking.

Related: Minimizing Your Housing Costs // Don’t Let the Banks Set Your Budget

So what do we do with our extra?

Despite that two-to-one investment-to-mortgage payoff ratio that is our general target, in 2015, we ended up going a bit higher than three-to-one in favor of investments. Part of that was because we got ahead of schedule, and still hit our mortgage payoff targets, so invested the rest. But that imbalance would tend to argue for putting more against the mortgage this year, relatively speaking. We’ll keep you posted on what we decide!

We know this is a topic that brings about lively debate, so let’s hear it — are you more predisposed generally to paying off your house early or investing more? Has anyone focused more on prepaying your mortgage, or on investing while letting your mortgage go to full term, and lived to tell the tale? Please share in the comments!