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If you have extra funds, you might be weighing two options: paying down your mortgage or saving for retirement. In this guide, we’ll explore which should come first.
Key Takeaways
- If you’re going to put extra money toward your mortgage, it’s usually better to do it early, such as within the first 10 years.
- It’s also better to start saving for retirement early, so you can reap the benefits of compound interest over a longer period of time.
- As a general rule, the younger you are, the more you should prioritize your retirement savings over your mortgage.
Option 1: Paying Down Your Mortgage First
Let’s say you’re finally in the home stretch with a mortgage you took out years ago. It’s been a long haul, and you’re tempted to pay it off in one final payment and finally be free and clear—or, at least, accelerate your payments a little to be done sooner.
While it may seem tempting to pay down your mortgage near the end, it’s actually better to do so at the beginning. Most of your money in those early years is going toward interest and doing little to reduce the loan’s principal.
So by making extra payments early on—and reducing the principal on which you’re being charged interest—you could pay considerably less in interest over the life of the loan. The same principles of compound interest that apply to your investments also apply to your debts, so by paying down more of your principal early, the savings are compounded over time.
Other Mortgage Considerations
Mortgage interest is not the same as other types of debt. It’s tax-deductible if you itemize deductions on your income tax return. In 2024, you can deduct home mortgage interest on the first $750,000 of a loan secured by your home ($375,000 if married filing separately). For home mortgage debt incurred before Dec. 16, 2017, you can deduct home mortgage interest on the first $1 million of indebtedness ($500,000 if married filing separately).
If you need something to reduce the amount you owe the Internal Revenue Service (IRS), the mortgage might be worth keeping.
The Tax Cuts and Jobs Act (TCJA) of 2017 nearly doubled the standard deductions allowed. This eliminated the need for many taxpayers to itemize their deductions and led many homeowners to forego using the mortgage interest tax deduction.
If you have an adjustable-rate or other non-standard mortgage, paying down the mortgage—even if it’s later in the game when you’re paying off a greater portion of principal—can be an advantage. Building equity in a home that is financed by an adjustable-rate loan will make it easier for you to refinance to a fixed-rate mortgage if you ever decide to.
Also, if homes in your area are seeing little appreciation—or even depreciation—paying down a mortgage is a way to keep from going underwater (that is, owing more than your home is worth).
Option 2: Funding Your Retirement First
Just as it’s better to pay a mortgage off (or down) earlier, it’s also better to start saving for retirement earlier. Thanks to compound interest, a dollar you invest today has more value than a dollar you invest five or 10 years from now. That’s because it will be earning interest—and the interest will be earning interest—for a longer period of time.
For that reason, it generally makes more sense to save for retirement at a younger age than it does to pay down a mortgage sooner. You can estimate your retirement savings with the U.S. Social Security Administration‘s calculator.
Extra Mortgage Payments vs. Saving for Retirement
Assume you have a 30-year mortgage of $300,000 with a fixed 4.5% interest rate. You’ll pay $247,218 in interest over the life of the loan, assuming you make only the minimum payment of $1,520 each month. Pay $1,896 a month—$376 more—and you’ll pay off the mortgage in 20 years, and you’d save $92,000 in interest.
Now, let’s say you invested that extra $376 every month instead, and you averaged a 7% annual return. In 20 years, you’d have earned about $186,000 on the funds you contributed. Keep depositing that monthly $376, though, for 10 more years, and you’d end up with almost $429,000 total in earnings.
So while it may not make a huge difference over the short term, over the long term, you’ll likely come out far ahead by investing in your retirement account.
A Compromise: Funding Both at Once
Between these two options is a compromise: fund your retirement savings while making small additional contributions toward paying down your mortgage. This can be an attractive option in the early phases of the mortgage when small contributions can reduce the interest you’ll ultimately pay.
Why Would I Prioritize Paying Down My Mortgage?
By making extra payments early on—and reducing the principal on which you’re being charged interest—you could pay considerably less in interest over the life of the loan.
If you have an unusually high interest rate on your mortgage, it may make financial sense to pay down the debt first—or look into refinancing.
That said, you should balance paying down a mortgage against the return prospects of other savings options.
Why Should I Prioritize Retirement Savings?
Consider this when thinking about saving for retirement: thanks to compound interest, money you invest today will grow and be worth more by the time you’re ready to enter retirement. That’s because it will be earning interest—and the interest will be earning interest—for a longer period of time.
What Are the Tax Considerations of Paying Off Your Mortgage?
If you need something to reduce the amount you owe the IRS, the mortgage might be worth keeping. It’s tax-deductible if you itemize deductions on your tax return.
The Bottom Line
Typically, you shouldn’t sacrifice your retirement plan by focusing too much on your mortgage. By prioritizing your retirement-savings goals first, you can then decide if any additional savings are best spent on further contributions to your mortgage or on other investments. The money you spend paying off your mortgage won’t be compounding, and the rate at which it grows in, say, an index fund might be greater than your rate of interest on your mortgage.