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Paying Off Your Mortgage vs. Saving for Retirement

Which one is more important?

Senior couple meeting financial adviser for investment-2

Are you at a point in life where you are free from all debt other than a mortgage—and really starting to save heavily for retirement? You may be thinking of just paying off your mortgage to get that off your plate, and then contributing more to your retirement once the mortgage is paid off. But is this really the best approach?

There are some small benefits to paying off your mortgage early. You will pay less interest in the long run, and it can be really freeing, on an emotional level, to know that you own your home outright and no longer need to make payments to the bank. However, the money you put towards paying your mortgage off early would be better off invested in your retirement accounts. Here's a closer look at why that approach may be the smarter one.

Mortgages Usually Have Low Interest Rates

If you have been focusing on paying off consumer debt and credit card debt over the years, you're likely in the mindset that all debt is bad and needs to be done away with ASAP. However, there is a big difference between credit card debt, which usually comes with a 15% or even 20% interest rate, and mortgage debt, which often has a 3% or 4% interest rate.

Of course, you want to pay off high-interest consumer debt quickly. It's costing you a fortune to have that debt! But it is not costing you a fortune to hold a mortgage at 3% or 4%. If you were to instead invest your extra money, rather than throwing it towards the mortgage, you could easily earn 10% interest or more. In the long run, you will come out ahead by paying off your mortgage on schedule and putting your extra funds into your retirement accounts.

It's Hard To Beat Time in the Market

Far too many people put off saving for retirement for one reason or another. You don't want to pay off your mortgage to become just another reason you delay investing in your retirement. Time and time again, it is demonstrated that time in the market is the most important factor in determining how your investments will grow. Thanks to compounding interest, the money you invest now will earn you way, way more than the money you invest down the road.

An Example

How much of a difference will investing an extra $100 a month in retirement make? Well, if you invest just $100 a month for the next 10 years at a 10% rate of return—which is a pretty typical return on a good mutual fund—you will have $20,000 at the end of that 10 years. And approximately $8,800 of that will be interest. If you were instead to put an extra $100 a month towards a 4% mortgage in order to pay the mortgage off over the next 10 years, you would only save $2,517 in interest. So in the long run, you end up $6,283 ahead by putting that money into retirement instead—and that's not even considering the interest the money will keep earning in the years to come!

While it can be tempting to put all debt behind you and pay off your mortgage early, this is rarely the smartest choice from a mathematical standpoint. You are better off investing in your retirement as early as possible, and just paying off that low-interest mortgage slowly over time.

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