“Should I use my extra money to pay down my mortgage faster, or should I invest more?”

“Should I sell my investments to get a full 20% down payment or should I keep it in the market?”

These are two variations of the most common financial planning question I hear from clients. Here are some thoughts to consider when you make these decisions for yourself:

When To Pay Down and When To Invest

Historically, the stock market has averaged growth of 10% per year. Some years it grows more and some years less. In this low interest rate environment, your mortgage rate might be near 4%.

So, do you put your extra money in the market and chase a 10% return? Or, do you “earn” a guaranteed 4% when you make extra mortgage payments?

Some of you will look at that and say, “Duh! I will try to get the 10% return!”

Others will read it and think, “Hmm. A certain 4% sounds nice, and I really don’t like debt.”

If you have tolerance for market volatility and you have extra cash, I encourage you to invest! It is the right answer!

If you don’t like debt and building equity brings emotional satisfaction, I encourage you to pay down your mortgage! It too is the right answer!

It truly is a personal preference.

Keep Your Down Payment Funds Out of the Market

If you plan to buy a home within the next 3 years, keep that cash away from the stock market.

When you buy a house, you want your down payment fund to be liquid and ready. The stock market is near all-time highs right now. If you sold your investments now to fund a down payment, you could lock in profit. That is great!

However, there is no guarantee where the stock market will be when you finally find your perfect house. If there is a temporary decline, you would be selling your investments at a low to generate cash.

Money for short term goals should be kept in a money market fund, ultra-short bond funds, or other conservative liquid investments. Read my post on first time home buying for other tips.

“What If I Make a Smaller Down Payment, So I Can Keep More Invested?”

For many, private mortgage insurance (PMI) is a necessary nuisance. If you don’t have a large enough down payment, your lending institution will tack on PMI before they will extend a mortgage. That means extra costs for you. I would expect that your PMI be about 0.5% of your total loan payment per year (paid monthly).

Perhaps you have the money to make a full down payment and avoid PMI, but you are debating on whether to leave your money invested instead.

Essentially, you are choosing between the annoyance of paying for an “insurance” that doesn’t help you or getting some extra earnings in the market.

Here are the downsides to PMI:

  • The rate of return on PMI is literally 0%. You really get nothing for it.
  • If you start PMI, you may be stuck paying it according to the original amortization timeline. Paying larger mortgage payments later may not actually help it go away faster unless you pay for your home to be reappraised.
  • PMI is not tax-deductible like mortgage interest is.

Yes, if you had a smaller down payment, you could potentially earn more in the market with more money working for you. However, I suggest avoiding PMI when possible. Equity is your friend!

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Again, I cannot give a one size fits all answer on this topic. The answer for each person will be based on personal values, debt levels, cash flow, and more. However, these thoughts can help you start considering what is the best solution for you!