Updated on 09.15.14

Should I Pay Off Low-Interest Debt or Invest?

Trent Hamm

This week, The Simple Dollar attempts to address challenging questions in personal finance by looking at both sides of the story and figuring out some of the factors you need to look at to make a decision.

Most homeowners are in the process of paying off a large mortgage, one which requires a large payment each month, and the majority of those mortgages are at a fairly low fixed interest rate (yes, regardless of the hullabaloo about subprime mortgages, the majority of mortgages are fixed-rate long term ones). Often people earn substantially more than they once did and can either begin investing the money or begin making extra payments towards their mortgage.

Which is the right path? This isn’t just a question of numbers, but also a question of goals and philosophy. Let’s take a look at both sides of the equation.

Debt Freedom!

Debt freedom is a spectacular feeling. Suddenly, you’re no longer encumbered with a large mortgage payment each month and your monthly budget suddenly shrinks greatly. Many more lifestyle opportunities open up to you – you can switch to a lower-paying but more fulfilling job, or perhaps even make the leap and become self-employed.

Paying ahead on your mortgage isn’t just a monetary investment – it’s a psychological investment, too. Watching that balance falling brings about a sense of purpose and a sense of peace – your monthly financial burdens are slowly disappearing and soon you’ll be free of the burden of your mortgage.

Even if you look at it strictly as an investment, it’s not too bad. If you have a 6% home mortgage, payments towards that mortgage will earn 6% – guaranteed. No worrying about ups and downs in the stock market, no worrying about anything else – a guaranteed 6% return, which you’ll effectively receive when your mortgage is paid off.

Invest For Your Dreams!

It’s a simple comparison. Over the last thirty years, the Vanguard 500 index fund has returned, on average, over 12% per year. A home mortgage is thirty years long. Thus, unless your home mortgage is 12% or close to it, you’re better off dumping your excess cash into that index fund.

That’s not to say that there won’t be individual years where putting money in the home mortgage won’t be a better investment – there sure will be. But a long-term commitment to investing instead of paying off a low-interest debt will give you more money (provided, of course, the next thirty years of the S&P 500 grow like the last thirty).

We’re not looking at a short term window here – if you’re looking at just a few years, the debt repayment is probably a better investment because of the volatility of stocks. But if you’re looking to be cash ahead many years down the road, money in the Vanguard 500 – or a similar broad-based low cost index fund – will come out on top of money in the mortgage every time.

My Take

To me, this debate comes down to goals. What are your goals? If your goals don’t require a large bankroll – for example, if you dream of being self-employed or only working part time so you can be involved with volunteer work – you can likely achieve them much sooner by putting money into the mortgage than into an investment vehicle. However, if your dreams center around expensive items, like a large dream home or grand vacations or similar things, you’re probably better off in the investment vehicle.

For our situation, a direct route to debt freedom is the better choice for now. We’re looking at the strong possibility of another child, and if we choose to do that, one of us will likely become a stay-at-home parent. That means that eliminating debt now means lower monthly bills when that time comes, making the financial situation that much more tenable.

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  1. Jane says:

    It also depends on your financial and/or life situation. I bought my home in 2004 and began almost immedialtly to pay additional principal toward the mortgage. About a year ago, I found out I will porbably be transfered in the next year or so. Since I would need at least 5 years plus to pay off my loan (that’s if I was paying it off very aggressively), I decided to instead place that money into a money market fund that way I get to keep the inerest. When I get transfered, this additional moeny will become part of my downpayment. If for some reason my transfer situation changes, I can take this money I have been saving and put back onto the loan.

  2. Keri says:

    I’ve been wondering (and sorry that this is a little off-topic) but if a student loan is your only debt (which is about $25,000 with a interest rate of about 4%), what would be the best thing to do if you want to start saving for a downpayment on a home: try to put extra money toward the downpayment, or put any extra money toward paying down the student loan?

  3. shawn says:

    If you have a student loan interest at 4% and you’re in the 25% tax bracket your effective interest rate on the loan is 3% if you can deduct the interest. Let’s assume you could guarantee that you could make 6% on your investment. That would be an effective rate of 4.5% after taxes. So essentially your talking about a spread of 1.5% or 3% if you put it in a Roth or 401k. Hardly worth it. You essentially get something close to 3% on any additional principal you pay. You could invest it in mutual funds or real estate but there’s no guaranteed rate of return and you could end up with less net worth than you have now. Finally ask the question that Dave Ramsey always asks callers, would you go take out a student loan to invest? That’s essentially what you’d be doing.

  4. s says:

    @Keri –

    If you are comfortable buying a house while still having student loan debt, you should make the minimum payments and save the rest up for the house. While the investment (or high-interest savings account even) might not make you more money, it will keep it fairly fluid, so when it’s time to buy you can spend it. The chances that your home loan will be at 4% or less is pretty much 0, so the money would be better put towards the down payment than the student loan.

  5. Keri says:

    I guess what I’m really asking is – what looks best to a lender? Say I can save up $15,000 – would a lender like it better if I put $5000 down on a house and cut my student loan in half? Or put it all on the downpayment, or even put it all toward the student loan? I’m not so worried about the investment portion – I’m more wondering what looks best to a bank. Because let’s face it, my income is less than $40,000, which isn’t really much to work with. And even though my only debt is student loans, it’s a BIG debt.

  6. Johanna says:

    @Keri: It’s my understanding that with mortgage lenders tightening their standards these days, it looks much better to have a good-sized down payment. $15,000 may not even be enough – remember, you have closing costs to cover too – unless you are buying a REALLY cheap house.

  7. Michael says:

    I am debating this same issue. I am able to pay off my mortgage in eight years if I throw every extra dollar towards it. That includes any retirement savings during that period. I have no other debt and a full emergency fund.

    Advice anyone? Should I go hard core and pay off the debt in eight years or invest the money instead and just pay off the mortgage over time?

  8. Al says:

    Here’s a link to a Scott Burns article which swayed me to pay off my home. It is slightly dated but the concept is still true. Of course set aside money for retirement and have emergency funds too! But let Mr. Burns explain the concept of “imputed income” as in this article and you’ll see that a paid-off home is more than just a “feel good” thing.

    Here’s the link: http://www.dallasnews.com/sharedcontent/dws/bus/scottburns/columns/archives/1999/990525TU.htm

  9. I think greater efforts should be made to pay off the mortgage as soon as possible since they are generally at higher interest rates.

    But keep in mind that not all debt is bad. If you can consolidate your students loans, for example, at a rate less than what you could earn in a savings or money market account, you should definitely take your time in paying off the student loans. Yes, it is essentially taking a student loan to invest. But we’re not talking about investing in speculative stocks – we are talking about investing in relatively stable saving accounts.

  10. MS says:


    Are you including retirement and college* funding when you say ‘investment’? I would recommend putting those before any serious mortgage pay-off, if only to prevent any re-borrowing when those bills come due.

    *assuming you plan to assist with college, ignore otherwise

  11. Daron says:

    How is paying interest investing? If I am paying 6% interest on a loan, I am paying that money to somebody else. This is not going toward my principle, but some one else’s pocket. And, the more I put towards the principle, the lower the interest portion of the payment will be.

    However, any time I am paying interest to myself (savings, etc) I am increasing my money.

    You have to ask yourself, who do I want to pay money too? The bank, or myself? I’d vote for myself anytime.

  12. Daron says:

    “If you have a 6% home mortgage, payments towards that mortgage will earn 6% – guaranteed”

    How is paying interest investing? If I am paying 6% interest on a loan, I am paying that money to somebody else. This is not going toward my principle, but some one else’s pocket. And, the more I put towards the principle, the lower the interest portion of the payment will be.

    However, any time I am paying interest to myself (savings, etc) I am increasing my money.

    You have to ask yourself, who do I want to pay money too? The bank, or myself? I’d vote for myself anytime.

  13. LC says:

    I was hoping this would be one of your topics this week.

    We have a relatively low interest mortgage (6.0%). I will pay enough in tax-deductible interest this year to make my “actual rate of return” on this money about 7.5%. Still, doing the math, we could likely get a higher rate of return with investments, and that seems to make more financial sense.

    However, the psychological goal of being debt free is an important one, and the absence of a mortgage payment would give us a lot of freedom.

    In addition, although you can’t look at it as an emergency fund in the traditional sense (no liquidity), if you had your home paid off and then you happened to lose your job, the blow would be a lot lighter, and there would be no worry of losing your home if you couldn’t make those payments.

    What seems to make the most sense in our situation is to pay about as much to keep us on track to pay it off in half the time (since we could have gotten a 15 year mortgage).

  14. LC says:

    They are talking about paying extra principle on your mortgage, thereby reducing the amount of the loan and in turn reducing the interest you pay to the bank.

    Your argument would makes sense in terms of investing in order to pay cash for a house so you don’t have to give money to the bank at all. This is not possible for many people, and even if it was, the low interest rate that you can get on a mortgage often still wins out (i.e. if you can earn more money in stocks than you are paying out in interest, it’s still a good deal)

  15. Scott says:

    This is an interesting topic, we all no doubt have our own ideas of what works best.

    I just closed on our new home; I elected a 30yr @ 6.125%. I could have afforded the 15yr but because I’m in the midst of a major career change (retiring from the military) and haven’t settled in on my next employment racket I opted for the lower mortgage payment. I plan to make the payments as if I had taken the 15 yr plan, if I stick to that I’ll have it paid off in 17yrs or so. If my future employment doesn’t always work to my advantage I’ll have the lower mortgage payment to fall back on with no real penalty.

    What I want to avoid is having most of my “investments” tied up in a non-liquid asset like my home.

  16. Toby says:

    @ shawn: You quote Dave Ramsey: “would you go take out a student loan to invest?”

    In other words: Would I borrow money at 4% to invest?

    Answer: Hell yes! That is what is called “leverage”. Look it up. It’s essentially what you do when you take out a mortgage. Also, 4% is cheap money, I’d get as much as I could.

    See, this is why Dave Ramsey is an idiot in my book. His philosophy treats finance as black and white.

    Finance is not black and white! The sooner people realize this, the sooner they would stop quoting the asinine things that Dave Ramsey says.

    The real answer to your question there is “It depends.” Personally, I would jump on chance to borrow money @ 4%. As far as Keri’s situation, as long as the payments on the student loans weren’t a huge burden, I would stick to the minimums and start saving for other things. 4% is the cheapest money Keri will ever get a chance to borrow, you may as well *leverage* it while you can. Go ahead and build up an emergency fund, save for a house, start a business, whatever.

  17. Anne says:

    @Keri – your lender will definitely want you to make as big a downpayment as possible. They don’t care nearly as much about your student loan debt. The reason is that they’re worried about protecting their recovery in the event they have to foreclose.

    Say you buy a $100,000 house and put down $10,000 as a down payment. If the bank has to foreclose before you’ve paid down much of the principal, they have to recover $90,000 after transaction costs and closing costs (and a possible drop in the housing market). Not likely. If you put down $20,000, they have a much better chance of recovering the remaining $80,000. This is why banks require that you pay PMI if you take out a loan of more than 80% of the home’s value.

  18. Jen says:

    Toby is totally right on this one.

    Further, people should separate their debt from their emotions. Saying that their is psychological effect of paying off a mortgage makes no sense to me.

    I could have put every extra dollar into paying off my mortgage, but I invested it instead. Now I have enough money that if I had to or wanted to, I could just write a check for the amount I owe on my house, but instead, I’ll keep it invested and use it to earn even more money. My net worth is positive long before it would be if I just paid off my house.

  19. Debbie M says:

    If you are the type of person who is more motivated to commit extra money to one of these goals than the other, you should go with the one you’re most committed to. This will lead to the best payoff for you.

    If you are the type of person to get below-average returns, by freaking out and selling low and buying high, paying off the mortgage will give you the better payoff and give you time to practice investing with smaller amounts of money.

    Another issue is that if you invest the money, you can always use it to pay off the house. It will cost whatever fees your broker charges to sell off your stocks or mutual fund or to clean out your savings account or whatever, generally a minimal amount.

    If you pay off the house, you can generally get that equity back out of the house by getting a loan of some kind, but the fees for this are huge, and it’s a bigger hassle. (And therefore less tempting for frivolous things!)

    Either way, you are most likely to really need the money right when it’s hard to get. If you lose your job in a recession, you may no longer qualify to get a loan based on your equity, and the stock market may have plummeted, so your investments are at their lowest.

    I would never hold off on eight years of retirement investing to pay off a mortgage early, for so many reasons. 1) Although you will have more money to invest later, you may hit up against limits to how much you can invest tax-free. 2) Investing should be as long-term as possible; waiting eight years significantly increases your volatility. 3) It’s good to think of investing for a retirement as a baseline habit that you try to always do no matter what (once you can afford to eat, live indoors, and take care of medical issues).

    I’m the type who really wants my mortgage paid off but thinks she can do better with investing. I tell myself I can pay off my house when I have enough (especially if my lender is annoying me), or start pulling my house payments out of my investments when I have enough. I’ve sort of compromised on the pay-early vs. invest question by refinancing two years into a 30-year loan at 8.25% and with a big PMI payment to a 15-year loan at 6.675% with a low PMI payment. So I’m paying it off in 17 years instead of 30.

  20. klf says:

    toby and Jen certainly have valid points in their opinions.

    However, I work with people daily regarding debt, and although people “should” separate their debt from their emotions, for the vast majority of people, it simply isn’t a possibility.

    Now, I have no debt except for mortgage debt. Logically, I know that my mortgage interest is 4.5% and I could invest my extra money and earn 9% instead of paying extra towards the mortgage. But I also know myself well, and hate debt of any kind, and therefore pay extra on the mortgage.

    I suppose what I’m trying to say here is that while Jen states “…their(sic)is psycohological effect of paying off a mortgage makes no sense to me.”, it does make sense to a lot of other people, and to denigrate it by impplying that it’s wrong does an injustice to TSD discussion that one option is not more right than the other, but rather a personal choice.

  21. George says:

    Debbie M has the right idea in my book. Yes, I’d like my mortgage paid off quickly, but not at the expense of having no liquidity nor at the expense of my retirement savings. The taxable investments, including an emergency fund, are your cushion when things go wrong and if they’re not available because you’ve spent them on the mortgage, then you’re SOL (unless you’ve already established a HELOC, but that would debt and we’re not interested in acquiring additional debt).

    Thus I have 12 years to go on a 15 year mortgage that’s less than 5%. The emergency fund is primarily invested in an international bond fund yielding over 6.5% (because the US$ has been devaluing significantly in the past 4 years) and the rest of the taxable funds are in various stocks. My own track record for the past 15 years of stock investing has consistently beat the S&P500, so I’m not interested in index funds.

  22. Rick says:

    My opinion is: Invest!!!! All the way.

    But I know everyone has their own opinions, and I have yet to convince anyone :-)

  23. dave says:

    no debt would be cool. owning your own house in your 30’s. how can you beat that? i don’t believe you can.

  24. Matt says:

    I agree with Toby.

    I wanted to point out that the reason Dave Ramsey (and other well known financial advisors) offer advice like “pay off your debts first” is because they are trying to offer the most generalized advice possible. They offer advice that will benefit everyone even if they have higher opportunity costs.

    No one is going to come back to them and say “Hey you told me to pay off my debts and I did. I wish I hadn’t done that.”

    Always keep in mind where the advice is coming from, evaluate the reasons why they offer that advice and then see if it would be suitable for your situation.

  25. Shevy says:

    I knew you were going to do this as one of your A vs. B topics!

    One point that hasn’t been made yet is that all these comments are applicable specifically in the US where the norm is 30 year fixed rate mortgages with deductible interest.

    In other countries or if you have a non-traditional mortgage in the US the situation can be very different.

    Personally, I belong to the “pay off debt” school regardless. I’m not a fan of spending money in order to have a small portion of it returned to me in the form of a tax deduction. (Kind of reminds me of white bread. Let’s take out the fiber, the vitamins, etc. and return a small portion of the cheapest vitamins to you in synthetic form and we’ll call it enriched.)

    I also think that a bird in the hand is worth 2 in the bush. People are very fond of saying that you can get a higher return by investing but, unless there’s a guarantee, you might invest and (gasp!) lose money. (I know that’s never happened to anybody who reads this blog :) LOL)When you pay down on the mortgage you know where that money is going and can figure out exactly how much money in interest costs you’re saving.

    If you don’t have a 30 year fixed rate mortgage I think it’s even more important to pay down as fast as possible. Your interest rate could go up or you could have a balloon payment payable and for some unforeseen reason not be able to refinance (say your spouse just unexpectedly got downsized out of a job s/he’d had for 20 years).

    The dollar is not in great shape against other currencies, gold is over $800/oz, China is hinting that they’ll take their money out of US$ and invest it in other currencies instead, Citi has an $11 billion write down. Should I go on?

    In uncertain times I want to reduce or eliminate all possible debt and have as much control over my life as possible.

    Right now we have a fully paid home in a community where we plan to retire and are renting a relatively inexpensive apartment in the city where we currently work. If everything were to go sour, we could leave the city and live at extremely reduced cost in our paid-for home. We couldn’t continue to save for our dream acreage and future career change or put away a bunch of money for retirement, but we could manage for at least 2 years *even if we didn’t have jobs for that length of time* and *without* any type of government assistance.

    That is peace of mind I didn’t have a year ago, when I still had a mortgage!

  26. Jane says:

    There is one other point I just tought of about this whole debate. One of Dave Ramsey’s key point is after you pay off the house you can take your payments and invest them – therefore investing “a whole lot of money” at that point. However, what if you house payment or other debt is really low compared to your income. I just realized that even if I payed off this debt and than took that money and added it to my investments I would not be investing “a whole lot more money” every month compared to what I do now.

  27. Michael says:

    Hi everyone!

    I ran some numbers on my earlier scenario about paying off my house in eight years to the exclusion of all other retirement savings or investments. Basically I wanted to see if it was better to go all out and pay off the mortgage in eight years and then invest all that money that was going towards the mortgage payment or just go with a 15 yr. mortgage and invest a little on the side. The interesting thing is that they both came out to be roughly the same totals after 15 years!

    So I guess it really does come down to personal preference…. I am still leaning towards the prepay option because it eliminates a major “have to pay” in my life and would give me far more options in terms of career and lifestyle. Of course either option requires discipline because you wouldn’t want to go out and blow all the newly available money after paying off the mortgage. The plan only works out if you can devote a good chunk of that money towards retirement.

    In response to the other posters comments about hitting the maximums for retirement savings, that is true. For 401Ks it is currently $15,500 a year and $5,000 per person for Roth IRA’s. Of course you could always invest the rest of the money in taxable accounts.

    The other argument usually made against paying off the mortgage early is losing the tax deduction but if you max out your 401K contributions after paying off the mortgage, it would help ease that blow.

  28. Keri says:

    Thanks for all the info guys! I didn’t know about things like PMI, so that was really helpful to bring it up. I’m still years away from even THINKING about buying a home, but I know that if I’m ever going to be in a position to buy I have to learn about all these things ASAP. THANKS!@

  29. Tim says:

    people make to much about paying off your mortgage. I agree with others on your comments about paying your mortgage off as an investment: paying off your 6% mortgage is NOT like making an even 6% return. Your equity in your house is depreciating at the rate of inflation. Second, depending on your area, even if you get a reasonable 2% appreciation on the value of your house over the lifetime of your mortgage is still below inflation, so you are losing money. Third, it will cost you more in interest to tap your equity through a HELOC at 8% if you still plan on living in the home. Fourth, if you sell your house, then you still have to buy another one, and you may not be able to get into another one cheaper down the line. If you decide to do a reverse mortgage, you will get far less than what you paid into your mortgage. So, what are the benefits of paying off a mortgage early? I’m not sure.

    If you want to have flexibility in your net worth, then don’t pay off your mortgage. If you want to be richer in net worth on paper, but not have the flexibility to tap the equity from your home, then pay off your mortgage early. I for one would rather invest the money elsewhere.

  30. Michael says:


    The main idea behind paying off your mortgage early is being able to allocate more of your income to your gain rather than the bank.

    If you pay off a mortgage over 30 years, you are sending thousands upon thousands of dollars in interest to the bank. That is money that is gone forever. However, whatever you pay in principal often does come back to you in the form of equity when you sell your home. If you pay off your mortgage early, you are effectively paying less interest to the bank which is like a 0% return.

    So ultimately, paying off your mortgage early is really about being able to allocate more of your money towards your own investments that earn you money rather than flush them away to a bank.

  31. Toby says:

    @ Michael: If you pay off a mortgage in a vacuum, does it save on interest? Yes. Too bad we don’t live in financial vacuums.

    In other words, your reasoning is much too simple. Paying off your mortgage or investing is about allocating your money towards one end or the other. Your argument that not paying your mortgage down early means you pay more interest to bank ignores many facets of the debate. If your money can be put to work earning a higher rate than you are paying in mortgage interest, you would actually be making money, no matter how much you pay in interest.

    In fact, if I have a low interest mortgage or student loan and I can invest my money elsewhere for a higher return, I will always come out ahead in the long run. Period. The numbers do not lie.

    Whether one believes that their investments outside the mortgage/student loan can appreciate at a higher rate than what they are paying on that loan is a personal exercise. Could go either way.

    Simply looking at the total amount of interest you pay to the bank and declaring that you are smarter because you ended up paying less interest is misguided. You need to look at your whole financial picture to figure out if prepaying your mortgage is/was a smart move or not.

    Aside from my belief that I will outperform my mortgage rate over the long haul, I am also a big fan of “huge cash cushions”. I’m not talking E-Funds here. I’m talking “HUGE CASH CUSHIONS”. The kind that let you start a business, buy an investment property, etc. That makes me smile.

    A paid off mortgage? Sounds like I own a poorly performing, illiquid asset.

  32. Tim says:

    Michael: this is contingent upon you not gaining returns off of the amount you do not use to pay ahead your mortgage. it is also contingent upon whether you can sell your house after you pay off your mortgage and get into a different house. if you do not sell the house or can’t get a HELOC to tap your equity, the equity in your house is absolutely worthless. if you are sitting on a large stash of house equity, it is exactly opposite to “being able to allocate more of your money towards your own investments”.

    of course people should do the raw number calculation of whether what they can afford extra towards paying mortgage off really yields anything in the end versus investing the money. They also should take into consideration if they will be able to sell the house in order to tap the equity and buy a different house for cheaper, in an area they want to live in; whether they will be able to get a HELOC down the road at a higher interest rate if they have no income stream; the cost of reverse mortgages which gives far less value than the actual equity in the house; the depreciation of the home equity not earning any interest; the housing market in the area, whether it is and will be flat, appreciating, or depreciating. People really need to stop thinking of a mortgage as some readily accessible pile of cash: it simply is not.

  33. Tim says:

    oops, I meant to say home equity rather than mortgage at the end.

  34. Linnea H says:

    I have to agree with Debbie M: ‘If you are the type of person who is more motivated to commit extra money to one of these goals than the other, you should go with the one you’re most committed to. This will lead to the best payoff for you.’

    I will have paid off one of my student loans next month, by living frugally for 1,5 yrs. I managed to stay on the frugal track because of this goal. If I hadn’t set up this goal, I would probably have spent at least 75% of that money on crap. Therefore, for me, I avoided interest payment of around 2,5% (student loans are extremly low interest in Sweden) but missed interest income of 0,25*8% = 2%.

  35. Sandy says:

    My husband and I are firmly on the Let’s get rid of the mortgage” track. We’ve been maxing out the retirement plans, no CC, Student loans were repaid in 6 years instead of 10 (and that felt really good!), and we’ve been pissing away money on crap and eating out way too much. Last summer, he wanted to pay cash for a new car, and I said, hey…what would happen if we put that cash toward the mortgage? Well, it knocked off 4.5 years of the mortgage. We played with the numbers, and saw that we could, by going back to frugal land for a couple of years, and forcefeeding our mortgage down, it would be done in a little more than 2 years. That would leave 20 years of not paying for a mortgage at all! And then we figured out how much we’d put into our pocket rather than the bnks, and we were looking at some serious numbers! So, for 20 years, we’ll have that cash flow (plus all the monthly extra that currently is going toward the prepayments)available to invest more, play and travel more, or just see our kids through college and weddings without the monthly commitment. Yes, someone could likely make more money in stocks, but I really like a sure thing.
    Oh…also, even if our plan “fails” and we can’t continue with the 2 year plan, by throwing as much as we’ve thrown at it in the last 4 months, we’ve now brought it down to the point of having knocked off 10 years anyway, so worst case, we pay off the loan in 18 years rather than 30. I only wish that we had done this a few years ago!

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