Prepay the mortgage or invest the money?

Why the usual comparison is misleading

The question comes up whenever there is a bonus, an inheritance or simply a savings account that has grown. The typical way people answer it is to look at the total interest saved by prepaying, which is large and certain, and compare it with a guess at what the investment might earn. That comparison is unfair in two directions at once.

First, "interest saved" is quoted over the whole remaining term, while an investment return is usually quoted per year. A big lifetime number next to a small annual percentage makes prepaying look better than it is. Second, the two options leave you with different monthly cash flows. If you prepay and keep the same term, your monthly payment drops and you have money left over every month; if you invest, you keep paying the full amount. Unless you account for what happens to that monthly difference, you are comparing two different budgets.

A fair comparison keeps everything else equal: same starting lump sum, same monthly outgoings, same time horizon. Then the only question left is what that money earns.

Setting up a fair comparison

Take a common case: a $300,000 fixed-rate mortgage at 6% over 30 years. The monthly payment is $1,798.65. A year in, you have $50,000 to spare. The two paths are:

• Prepay: put the $50,000 against the loan in month 12 and keep the original end date. The lender recalculates the payment on the smaller balance, and it falls to $1,495.15 — $303.50 a month less. You invest that $303.50 every month for the remaining 29 years.
• Invest: keep paying $1,798.65, and invest the $50,000 as a lump sum for the same 29 years.

Both paths now cost exactly the same each month, and both end at the same date with the mortgage paid off. The only difference is how much you have in investments at the end. That is a clean, apples-to-apples comparison, and you can reproduce it with the mortgage calculator (for the new payment) and the compound interest calculator (for the two investment balances).

If you prefer to keep the payment the same and finish early instead, the loan is paid off 116 months sooner and saves $159,653.90 in interest. That is a real benefit, but it is the same decision in a different form: from month 245 onward you would be free to invest the whole payment. The reduce-the-payment version is easier to compare, so the rest of this guide uses it.

The numbers

Here is what each path is worth after 29 years for three different investment returns, with growth compounded monthly and the $303.50 invested at the end of each month:

The middle row is the key result. When the investment earns exactly the mortgage rate, the two paths end up within a few dollars of each other; the tiny gap is only the rounding of the monthly payment to the cent. This is not a coincidence. Prepaying a loan is mathematically the same as an investment that earns the loan's interest rate, guaranteed, with no fees and no tax on the gain.

So the whole question collapses into one comparison: will the investment reliably earn more than the mortgage rate, after tax, fees and allowing for risk? If yes, investing wins on average. If not, prepaying wins, and it wins with certainty.

The rows also show how asymmetric the result is. At 8% the investor is about $90,700 ahead; at 4% the investor is about $39,600 behind. Higher expected returns come with a wider range of outcomes, and the table shows only the average path, not the bad years.

What should actually decide it

The after-tax rates on both sides

Compare like with like. If your mortgage interest is tax-deductible — in the US that depends on whether you itemise, and most households now take the standard deduction instead — the effective cost of the loan is lower than the headline rate, which makes prepaying less attractive. On the investment side, taxes and fund fees come off the return; money in a tax-advantaged retirement account keeps more of it. Use the net rates in the calculators.

Risk and the order of returns

A 6% mortgage prepayment earns 6% every year. A stock portfolio that averages 6% or more over decades can still lose a third of its value in a bad year, and a bad decade early on hurts more than one late. If losing money would force you to sell at the wrong time, or would keep you awake, the guaranteed return has real value that the table does not show.

Liquidity

Money paid into a mortgage is hard to get back: you would need to refinance or borrow against the home, usually at a cost and only if a lender agrees. Money in investments can be sold. Most financial planners suggest keeping an emergency fund of several months of expenses in cash before making any extra repayment, and clearing expensive debt such as credit cards first — a card charging 20% is a far better "investment" to pay off than a 6% mortgage.

Employer matches and other free money

If your employer matches retirement contributions, contributing enough to get the full match is an immediate, guaranteed return far above any mortgage rate. Take that before prepaying.

Your rate may change

With an adjustable-rate mortgage, the rate that matters is the one you expect to pay in future, not today's. If rates are likely to rise, prepaying locks in savings at the higher future rate. If you might refinance to a lower rate, the benefit of prepaying falls.

Check the loan terms

Some loans charge a prepayment penalty, limit how much you can repay early each year, or only recalculate the monthly payment if you ask (a "recast", sometimes for a fee). Without a recast, an extra payment shortens the term instead of lowering the payment. Read the note or ask the servicer before sending money.

Run the comparison for your own loan

1. Open the mortgage calculator. Enter your remaining balance, rate and remaining term. Add an extra payment of your lump sum in month 1 and choose "keep the term, pay less each month". Note how much the monthly payment falls.
2. Open the compound interest calculator twice. In the first, enter the lump sum as the starting amount, your expected net investment return, the remaining term in years and no contribution. In the second, enter a starting amount of 0 and the monthly saving from step 1 as the monthly contribution.
3. Compare the two final balances. Then repeat with a lower and a higher return to see how wide the range is. Where the two paths cross is the return you would need just to break even — it will be close to your mortgage rate.
4. Use the percentage calculator to express the gap as a percentage of the amount you invested, which makes it easier to weigh against the risk you are taking.

The calculators run in your browser and store nothing, so you can use your real figures.

Limits of this analysis

• A constant return is a simplification. Real investments have volatile, uncertain returns. The comparison shows the average case, not the range of outcomes.
• Inflation affects both paths equally in this setup, so it does not change which is better, but it does mean the final figures are in future dollars.
• Taxes are not modelled. Deductions, capital gains tax and tax-advantaged accounts can shift the break-even return up or down.
• The monthly saving must actually be invested. If, in practice, it would be spent, the prepay path loses its second half and looks worse than shown here.
• This is not financial advice. It is a method for comparing two options. For decisions involving large sums, a fee-only adviser can take your full situation into account.

Sources and further reading

• Consumer Financial Protection Bureau: How does paying down a mortgage work?
• IRS Publication 936: Home Mortgage Interest Deduction
• Investor.gov: Compound interest calculator