As you build equity in your primary residence by paying off your mortgage over time, it will likely become one of your largest assets. Many physicians dream of being free of the shackles that come with needing the monthly cashflow necessary to pay their large mortgage payments. As such, many doctors aspiring towards FIRE (financial independence and retire early) choose to pay down their mortgages as quickly as possible to become debt free. Of course, this decision is not always straightforward. Secondary to low interest rates over the last few years, many physicians have elected not to pay down their mortgages and invest that money elsewhere instead, in hopes that returns on that money invested would outpace the interest being paid on the mortgage. As interest rates continue to rise, the decision to pay down the mortgage or not has become less straightforward.
Neither one is a bad plan, as both mean you’re focusing on your future. Which one is best for your circumstances and financial goals can depend on multiple factors, which we cover below.
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Questions to consider before approaching the mortgage payoff debate
As we alluded to above, putting your money towards a mortgage instead of using it elsewhere has opportunity costs that need to be weighed. With so many physicians on our doctor communities having locked down low interest rates over the last few years, the question has often come up about whether it makes sense to pay down the mortgage or instead invest that money elsewhere.
The general consensus, unless someone was eager to become debt free, was that leveraging low interest debt is a great way to generate long term wealth through investments like long term rental properties or by compounding returns in a stock market investment portfolio, which will grow your net worth significantly over time.
Before we dive deeper into the mortgage or investing debate, it’s important to make sure you’re in the position to do either. Here are a few factors to consider before continuing.
Do you have an emergency fund saved up to cover your expenses?
Do you have other (especially higher-interest) debt you haven’t paid off?
Do you have a large upcoming expense you haven’t saved for?
Are you investing a baseline amount into retirement accounts to ensure you’re on track to retirement?
If you haven’t covered these basics of personal finance yet, in most cases it’s probably in your best interest to address all of them before entertaining the thought of paying down your mortgage early.
Learn more on our personal finance primer for physicians.
Should I pay off my mortgage early or invest?
Once you have the foundations down and are sure that you have additional income to work with, then you can start thinking about the harder questions, which will be much more individualized to your personal situation, your risk tolerance, and how debt averse you are.
You’ll be considering the following questions:
What is your mortgage interest rate compared to the average returns on your investments?
What level of risk are you willing to take?
Would you feel more financially stable without a mortgage?
Are you financially stable now?
How quickly could you pay off your mortgage with the additional income you have?
Can you invest more into tax-advantaged accounts?
How soon are you hoping to retire?
Assessing the math of paying off your mortgage early
First, let’s just look purely at the easy math.
To see how the math plays out for your specific situation, search online for a mortgage amortization spreadsheet. Plugging in how much you have left on your mortgage with your interest rate and what you have available to add as extra payments will show you how much you can save in interest payments.
Using an online investment calculator, such as the one on Investor.gov, can approximate how much you could earn by putting that money in the stock market instead over the same time period.
Compare the two. If there’s a vast difference between the two outcomes, you probably have your answer, unless you have another non-mathematical reason for why you’re leaning one way or the other (investment opportunity you can’t pass up, desire to have the house paid off ASAP, etc.).
Why the decision to pay off the mortgage versus invest is not as straightforward as comparing interest rates
While we wish this was easy math, it’s actually not. There are both pure math and financial considerations as well as practical and psychological considerations.
First, remember that once you pay off your mortgage, you’ll have built up more equity, which is great, but that money stored as equity in your home is far more illiquid than having money invested in a brokerage account. If you aren’t already on a stable financial footing, this can cause stress in a situation where you need to access your equity/money. If you have to leverage that equity to borrow money, such as with a home equity line of credit on your home (HELOC), it will have a variable rate that may end up more than the mortgage you were originally carrying.
Second, unless you’re in an area where real estate is appreciating rapidly, in most cases that equity won’t be growing for you in the background at as fast a rate as many other investments. The equity in your home is therefore a very conservative asset of your portfolio in terms of ROI for most people.
Third, there is no guarantee that you’ll make money if you choose to invest instead of paying back your mortgage. In fact you could lose money. in investing, whereas paying off your mortgage is a guaranteed ROI.
Fourth, remember that for most physicians with limited options to take tax deductions given our income level, your mortgage is paid in post tax dollars. That means in order for the return on investment to break even with paying the interest on the mortgage, you actually have to earn more money on the investment than the mortgage just to break even as capital gains tax on those investments will need to also be paid. What level of risk are you willing to take if your investments don’t do as well, compared to the guaranteed ROI of saved interest from paying down your mortgage?
Finally (and this is a big one), there is value to investments compounding in the background and growing without paying taxes until you sell. Whereas the mortgage is a one time payment that will eventually be over, the smaller the amount of money that you have invested early on, the smaller pot of money that’s growing for you and working for you in the background for all future years of investing.
Guidelines based on interest rates
Piggybacking, the decision is likely not straightforward unless you have a very low mortgage interest rate or a very high mortgage interest rate.
Low Mortgage Rates:
Some physicians are lucky enough to have mortgage rates in the 2% range. It’s hard to beat leveraging that debt to invest in the stock market, where average returns are closer to 8-10%, there are compounding returns, and even for the most conservative investors, many short term investments like high yield savings accounts and money market funds are currently yielding relatively safe returns in the 5+ percent range.
In general, what we’ve seen anecdotally on the communities is if a physician has an interest rate below 4% in 2024, they are opting to invest the money instead of paying off the mortgage early. This is likely because they feel that the chances of getting a return in the market on that money that outweighs the mortgage rate, even when accounting for taxes on that return, are generally in their favor particularly when accounting for the compounding wealth created that will expedite the growth of their net worth.
Exception: if you’re close to the end of your mortgage term, your money has less time to compound in investments. It may be worth it at this point to take care of the mortgage so it’s one less thing to think about in an already busy life, with the added benefit of relieving the pressure to earn enough money every month to cover your mortgage payments.
Higher Mortgage Rates:
Doctors with mortgages in the 7%-9% range will have a vastly different outlook and face a very different risk profile. With average market returns in a typical three fund portfolio over time at 8-10%, along with market volatility, paying off your mortgage can both make more sense financially and from a risk appetite perspective.
The difference between a 7% mortgage interest rate and a 10% investment return quickly shrinks, assuming you even feel confident that you’re going to get a 10% return. Unless a physician has a strong degree of confidence that the compounded returns over time or the returns of the particular investment they are choosing instead of paying back the mortgage are going to work out in their favor, we see that many physicians are instead opting to go for the psychological returns of financial freedom and FIRE rather than taking their chances with investing that money.
Middle Mortgage Rates:
In the 4%-6% range, you are basically stuck in the middle, and without a crystal ball, it’s a lot harder to predict what will maximize your investment the most. This is generally where we see physicians posting on our communities and asking what they should do, and where the math needs to be balanced more carefully with the physician’s personal financial goals.
Assessing your risk tolerance
While math is an important part of the discussion, it isn’t the only consideration to keep in mind. Everyone has a different risk tolerance level. For some, the emotional satisfaction of owning their home outright and having zero debt obligations is worth the difference they could have made in the market.
As you get closer to retirement age, not having a mortgage payment tying up a lot of your monthly expenses can be highly enticing. And this isn’t a bad goal to have. Having a paid off home provides stability and helps reduce stress by eliminating one of the largest monthly obligations you have.
Without a mortgage, you don’t need as much income to live off of, which can open you up to new career and entrepreneurship opportunities (or just time off and travel!) that you can’t afford with your mortgage payment.
Bringing it all together
To give you the full picture, we summarize the pros and cons of each situation below. Compare the advantages and disadvantages to your risk tolerance, your financial situation, and your financial goals to decide which situation is right for you.
Pros and cons of paying off your mortgage instead of investing
Pros
Frees up one of your largest monthly expenses, giving you more cash flow and less stress
Lowers risk regarding a secure living situation
You’ll pay less in interest over the life of the loan
Allows you to focus on other financial goals with more peace of mind
If you have an adjustable-rate mortgage (ARM), it protects you from fluctuations in the housing market
Cons
If you itemize on your taxes, you’ll no longer be able to deduct your mortgage interest
Your home equity is highly illiquid, making it hard to access it if you need it for something else
You may save less in interest than you could have earned in the market
Does not generate income during retirement
Pros and cons of investing instead of paying off your mortgage
Pros
You could earn a better return on your investment than you save on interest
If invested outside tax-advantaged accounts, the money is easy to access without penalties
Helps build up your retirement savings
You’ll have more money growing for you in the background for all future years, whereas paying off the mortgage was a fixed ROI
Cons
The stock market is volatile without a guaranteed ROI
You have to pay a mortgage payment monthly
If invested outside tax-advantaged accounts, you have to pay capital gain taxes on the growth
Consider splitting the difference
If you’re unsure if you should pay off your mortgage early or invest more, consider that it’s not all or nothing! This can be a great way to get your home paid off before retirement while allowing you to grow your portfolio for income generation.
For example, consider investing up to the maximum amount in all of the tax-advantaged retirement accounts, then tackling the mortgage with whatever cash remains.
If you are behind on retirement savings, calculate your financial independence (FI) number and see how much you have to save each month to reach your goal by your desired retirement age. Throw any remainder after investing that amount at your mortgage.
Learn more:
Assess your housing situation
If your reason for wanting to pay the mortgage off early is that you’re feeling the pinch of a high interest rate or a monthly mortgage payment that puts a squeeze on your budget, consider an alternative to paying off your mortgage early, such as:
Recasting your current mortgage to lower the monthly payment
Refinancing as interest rates drop
Downsizing to a smaller, less expensive home
For lenders that can help you with either a new purchase or refinancing, see our recommended mortgage lenders for physicians page.
Conclusion
While there are some situations that are more straightforward than others (i.e. very high or very low interest rates), most physicians in 2024 will fall in between, and have to balance the financial benefits of each option with the psychological and practical benefits of each option. Paying off your mortgage early might not be the logical conclusion when assessing the money aspect, but if it gives you peace of mind and aligns with your vision of financial independence, it’s the right decision for you. Alternatively, if you’ve got somewhere to invest the money that you strongly believe will pay off in the future, such as buying into a private practice or buying into an ambulatory surgical center, it may make sense to keep that mortgage even if the short term math is favorable towards paying it off.
Learn more on our primer on mortgages for physicians.