Pay Down the Mortgage or Invest the Surplus?

The question comes up on almost every call. My mortgage is at 6.5%, the market averages 10%, so why would I pay the mortgage down at all? It's a fair question. The two numbers aren't the same kind of number.

Paying down a 6.5% mortgage earns exactly 6.5%, every year, with no bad years, and after tax. Since 2018 most households take the standard deduction, so the mortgage interest usually isn't reducing anyone's tax bill, which makes the 6.5% a true after-tax return. The market's 10% is a long-run average with years of minus 20 inside it, and the gains get taxed when you sell unless they're inside a retirement account. On the same footing, the gap between a guaranteed 6.5% and an average that shrinks after tax and can go negative in any given year is a lot narrower than the headline.

The rate changes the answer. At 3%, paying down the mortgage is a guaranteed 3%, and a savings account can pay more than that, so the surplus probably belongs somewhere else and the plan still helps through the float. At 7% or higher, a guaranteed 7% is a return most investors would sign for on the spot, and the chunk is hard to beat. In between, it's a judgment call, and a reasonable one either way.

Here's the thing the either-or framing misses. The chunk isn't paid for by the surplus alone. The float, the money that sits in checking between the paycheck and the bills, lowers the interest on the line of credit all month whether or not you invest a dime, and that part is free. The surplus is what pays a chunk back, so the real question is how big a chunk you repay each cycle and how much of the surplus goes elsewhere. The match comes first regardless, and that's spelled out in take the 401(k) match first.

The third option is the policy. Cash value life insurance grows on its own schedule and stays borrowable, so a dollar that goes there can later be the chunk, which is the one dollar, two jobs idea applied to the surplus itself. It's slower than the market's good years and steadier than its bad ones. Whether that trade fits depends on the household, and it's a design question more than a rate question.

I'm a licensed insurance broker and not a registered investment advisor, so this is how to compare, not what to buy. Write your mortgage rate on one side of a page. On the other, write the after-tax return you'd need to be certain of beating it. Then decide how much of the surplus you want riding on an average and how much on a guarantee, and set the chunk size from that.