Anyone who has a mortgage has probably wondered at some point whether it’s better to use any spare cash to pay down their mortgage faster or use the money to invest.

Recently on the Canadian Money Forum someone asked a classic question – should I put the extra money I have towards my mortgage or use it to invest?

It usually depends on the person’s circumstances but in general when most people consider paying down their mortgage faster they only consider the interest rate of the mortgage – which is only part of the picture.

### Paying Down the Mortgage

Paying down debt (including a mortgage) is something that provides safety and security. You know that if you put any extra money towards your mortgage, you are guaranteed to pay less interest.

Paying down debt is like getting a guaranteed rate of return on your money. The interest savings is the return you’ll get and it’s relatively easy to figure out by using an amortization calculator – click here to enter your numbers.

If you are faced with an unknown job situation or have a variable income, putting extra money on your mortgage means you’ll have a lower balance in the future. This means you’ll have lower monthly payments the next time you renew your mortgage since you’ll owe less (assuming interest rates stay the same).

### Investing

The other option is to use the cash to invest – something that doesn’t offer a guaranteed return but could (potentially) lead to a higher rate of return. More risk means the potential for more reward, and investing instead of putting the money on the mortgage is no different.

Investing gives you the ability to put money into a registered account (creating a tax deduction for RRSP contributions) or a tax free savings account (TFSA) and with the TFSA limit recently increased, now is a good time to start contributing if you haven’t already.

### The ‘Hybrid’ Approach

The real value of paying down the mortgage isn’t the interest savings. With rates as low as they currently are, the interest you save will likely be minimal.

The best approach for anyone looking to use extra funds to pay down their mortgage is to consider a ‘hybrid’ approach – using the money to pay down their mortgage and then putting more money each month towards investing.

In the case of the person asking the question their mortgage was up for renewal soon. If they put the money on the mortgage principal before renewing, their monthly payments would decrease.

Rather than spending the difference in monthly mortgage payments, I suggested they consider putting the extra money towards their investments each month.

Their interest rate was low (2.30%), so the savings on the interest would be minimal. But what happens to their total return if they invested the difference?

Rather than only saving the interest, they’d earn even more by investing the difference monthly.

**Scenario**: Joe has a mortgage of $350,000 that is up for renewal soon. The interest rate on renewal is 2.30%. He has not made any TFSA contributions in the past so the full amount is available. He has $30,000 to either put towards the mortgage or invest in the TFSA. He can make 7% return if the money is invested. What should he do?

Here’s how the numbers would look if he put the money towards the mortgage and used the difference in monthly payments to invest.

__Mortgage paydown and investing:__

Old mortgage payment: $1,533

New mortgage payment: $1,402

Difference: $131 (to be invested monthly for 5 years)

Interest savings (over 5 years): $3,173

Value of investments (after 5 years): $9,500 (approximately)

__Investing:__

Value of investments (after 5 years): $42,000 (approximately)

*Joe would still have a higher return by simply investing, but the mortgage pay down may give him the flexibility he needs in the future. *

It should be noted that this situation isn’t for everyone and doesn’t take into account personal circumstances like TFSA contribution limit, appetite for risk and need for liquidity.

But on the other hand it clearly shows that paying down your mortgage may give a higher return than you think.

**Conclusion: **paying down any debt like a mortgage is a guaranteed rate of return because you will pay less interest. When faced with either putting money on the mortgage principal or investing, the best strategy might be to do both – putting the money on the mortgage and then investing the difference. This assumes you’re disciplined enough to put the monthly difference towards investments and continually reinvest the amount.

*What do you think? Would you pay down the mortgage or simply invest?*

**Related**: How to Reduce Your Mortgage Penalty

**Related:** Mortgage Basics Everyone Should Know

Potato says

There’s a math error — the obvious choice is investing straight up if you know you’re going to make 7%.

It looks like you’re counting the interest savings twice in the first approach (freeing up cash flow to invest and then again as part of the total return).

Let’s look at it again, but show the net worth figures and not get distracted by savings

rates.Straight invest:

$350,000 mortgage, no excess cash flow, $30,000 invested for 5 years at 7%.

End of 5 years: Mortgage owning is $295,031, investments worth $42,077. Net worth -$252,954.

Hybrid: Mortgage paid down to $320,000 at start of term. Payments now $1402 — excess cash flow of $1,572/yr.

End of 5 years: Mortgage owing is $269,743, investments worth $9,357. Net worth -$260,386.

Straight investing leaves you ahead by about $7k. Now of course all the other factors come in to play about risk tolerance and feelings about debt…

Dan says

Hey Potato, good catch – it turns out one of the formulas in the spreadsheet wasn’t calculating correctly. The return is higher by simply investing but he also mentioned a potential job loss in the future and he could benefit from lower mortgage payments if that happened, and as you mentioned risk tolerance also comes into play. What strategy would you take?

Stephanie@the money savvy blog says

People should only be making extra payment on their mortgages if they don’t have any consumer debt and already hold a good chunk of savings, regardless of investment types.

A mortgage is a long-term debt by nature. For most people, there are many other financial priorities coming before this, explaining why speeding-up payment is underrated.

Dan says

That’s true, and these comparisons really only make sense assuming there is no consumer debt to be paid off

Potato says

Well, I’d go with a split hybrid option: most people are fairly risk averse so paying down the mortgage is appealing, but the lower payments still have to be made in the event of a job loss, so there’s a case to be made for keeping liquid funds outside of the mortgage.

In the worst-ish case, you could choose to invest and see your investments tank by 50% just as you hit a job loss of say up to 6 mo. So I’d keep a ~year’s worth of cash needs liquid and invested (giving me 6 mo worth in the worst case) and throw the rest at the mortgage. Adjust up/down depending on your scenarios.

Which works out to roughly investing half and paying down the mortgage with half. For the more risk averse, they can hold a smaller liquid emergency fund in cash and consider the interest rate differential the cost of liquidity.

Sean Cooper, Financial Journalist says

I’ll be mortgage-free by October 2015, so this is music to my ears. If I could do it over again though I’d take a more balanced approach by investing in RRSPs and TFSAs.

Dan says

Wow Sean, that’s coming up so fast. Congrats! When you pay off the mortgage you’ll have plenty of time to start putting money into the TFSA and RRSP