Prepaying a Mortgage or Investing

Once the expensive debts are gone, a harder question appears. Extra money could go to the mortgage, which ends a large debt sooner, or into investments, which may grow faster but might not. People argue about this with great conviction on both sides, usually because each side is answering a different question. This chapter separates the arithmetic from the preferences: what prepaying really earns, how the two paths compare over the full life of a loan, what the simple comparison leaves out, and a test for "good" and "bad" debt that is more useful than the labels.

What a prepayment really earns

Every extra dollar of principal stops interest from being charged on that dollar for the rest of the loan. So a prepayment earns exactly the mortgage rate, guaranteed, with no market risk. Here is a typical loan with a steady extra payment.

The required payment on $300,000 at 6.5% is $1,896. Adding $400 a month ends the loan after 228 months, nineteen years instead of thirty, and saves $159,829 in interest. That saving is certain, which is its great strength.

The two paths, side by side

The fair comparison gives both paths the same money every month for the same thirty years. On the prepay path, the household sends $400 extra to the mortgage until it is gone, then invests the whole freed payment, $2,296 a month, for the remaining eleven years. On the invest path, it pays the mortgage as scheduled and invests $400 a month from the start. Both end year thirty with no mortgage. What differs is the investment balance, and that depends on the return.

If investments earn 5.0% a year, below the mortgage rate, the prepay path finishes ahead: $400,353 against $326,150. If they earn 8.0%, above it, the invest path wins: $563,420 against $475,242. When the return is close to the mortgage rate, the two paths end up close together.

That is the whole arithmetic: prepaying wins when investments earn less than the mortgage rate, and investing wins when they earn more. The difficulty is that you know the mortgage rate today and you will only know the investment return in thirty years. Long-run stock returns have historically been higher than most mortgage rates, but not in every decade, and a bond-heavy portfolio may earn less than the mortgage costs. The pay off mortgage or invest calculator runs this comparison with your balance, rate and assumptions, including tax.

What the simple comparison leaves out

Tax on the investments. Returns in a taxable brokerage account are reduced by tax on dividends and gains; returns inside a 401(k), IRA or HSA are sheltered. Investing that also captures an employer match starts far ahead of any prepayment.

The mortgage interest deduction, for most people, does not apply. Interest is deductible only if you itemize, and most households now take the standard deduction, which is $16,100 for a single filer and $32,200 for a married couple filing jointly in 2026. Unless your itemized deductions exceed that, your mortgage costs the full rate, which makes prepaying slightly more attractive than older advice suggests. The standard vs itemized deduction calculator shows which applies to you.

Liquidity. Money in the house is hard to get back. Prepaying does not lower the required payment, so if income stops the bank still expects the full amount, and borrowing against the equity at that moment may be expensive or impossible. Money in investments can be sold, at whatever the market offers that day. This is a strong reason to build an emergency fund before prepaying anything.

Risk. The prepayment's return is certain; the investment's is not. Someone who would sell in a downturn will not earn the long-run average, and for them the guaranteed return may be worth more than its rate suggests.

Inflation. A fixed-rate mortgage is repaid in dollars that lose value over time, while the payment stays the same. In years of high inflation that works in the borrower's favour, and it is one reason a low fixed rate is cheap debt.

Peace of mind and retirement cash flow. Entering retirement without a mortgage payment lowers the income you need each year, which can lower taxes and make a portfolio last longer. Some people value that certainty more than a possible higher balance, and that is a legitimate preference, not a mistake.

A better test than "good debt" and "bad debt"

Debt is often sorted into good (a mortgage, a student loan) and bad (credit cards, car loans). The labels are a rough guide, but they can mislead: an oversized mortgage that strains the budget is not good, and a cheap loan for a reliable car that gets you to work is not obviously bad. Three questions do the job better.

1. What does it cost after tax, and what does the money earn or save? Borrowing at a rate below what the asset reliably returns can build wealth; borrowing at a high rate for something that loses value rarely does.
2. Can you afford the payment in a bad year, not just in a normal one?
3. What happens in the worst case? A mortgage on a home you live in can be carried through a price fall if the payment is affordable. The same price fall on a heavily borrowed investment can wipe out your money. The next chapter is about that kind of borrowing.

A common order that follows from these questions: an emergency fund, any employer match, all high-interest debt, then a split between retirement investing and extra mortgage payments that reflects your rate, your tax situation and how much certainty you want. Splitting is not indecision; it hedges against not knowing which return the next thirty years will bring.