Investing extra dollars: mortgage vs. stocks

While there’s no one-size answer on whether to retire home debt or invest excess cash elsewhere, there are a couple of rules of thumb on the matter — and plenty of exceptions, depending on your age, cash flow and risk tolerance.

Other considerations aside, to determine which is more advantageous, compare the mortgage rate you have with the return you can get from another investment. Keep in mind the tax benefits of mortgage interest deduction; if you’re in a marginal tax bracket of 20%, for example, a 5% mortgage is more like one at 4% if you’re deducting the interest.

“If you believe over the next 10 years you can achieve a rate of return of X, then if your mortgage is higher than that, you should be paying off your mortgage. If the rate that you think you will be able to get from however you are comfortable investing is higher than your mortgage, then you wouldn’t pay it off,” said Norman Boone, president of Mosaic Financial Partners in San Francisco.

So, for example, if your choice is paying off a 4.5% mortgage or investing in a 2% certificate of deposit, it’s better from an investment standpoint to pay down the mortgage. Conversely, if you’re holding a 4.5% mortgage and you’re confident enough that you can earn 6% annually in the stock market, stocks are the better bet.

Of course having confidence in this unsteady economy could be the challenge: “Most people are probably not going to get a 6.5% return on their portfolio in the next 10 years” as the economy struggles to recover, Boone said.

Their mortgage debt, however, is guaranteed to linger until it is paid in full. And that makes paying down the mortgage — even in with today’s low rates — a wise move right now for some borrowers, especially those nearing retirement.

That said, if you have a longer investment horizon, it could be a different story. The total annualized return on a portfolio of 60% stocks and 40% bonds, rebalanced each year, is 9% over the past 50 years through August, according to Ibbotson Associates, a unit of investment researcher Morningstar Inc.

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