Why you should *not* make extra mortgage payments

If you own a home or two you may be thinking “Should I pay down my mortgage?”

Let’s start by going through the incentives of a bank to give you a loan. They can use bonds & federal programs to borrow money at a rate far lower than consumers can access. They then give you a mortgage at a markup over this price. 

They are using leverage (OPM) to fund their investment and they just take the spread between that and the mortgage rate to generate their returns. Ex: your banks borrows money at 3.00%, charges you 3.75%, and keeps the 0.75% spread.

This is actually great for you because now you can do what the bank does. You can borrow money at a rate that is *lower* than the return on most asset classes. This gives you the same form of leverage – OPM. You can use this cheap money to invest in higher returning asset classes like the stock market or real estate.

Let’s say that you took out a $300k mortgage on a $375k house (20% down) and you’re trying to shave off 11 years from your mortgage by paying an extra $500/mo to your mortgage as a principal payment.

11 years off the mortgage – sounds great right? And it is compared to putting money under the mattress, but if you somehow got to this article you’re likely trying to do the *best* thing with your money.

Let’s propose three options for what you could do with that money:

  1. Paydown your mortgage by $500/mo
    1. Expected return: Your APR on your loan, let’s call it 4%.
  2. Invest $500/mo in the stock market using index funds
    1. Expected return: 8-10% per year, in line with 30 yr averages
  3. Invest $500/mo in real estate by taking out more mortgages & acquiring cashflowing multi-family properties
    1. Expected return: 20-25% per year! Will add a future post to show how/why this is such a good asset class for working folks.

Ok now let’s look at the returns for each of these options over 19 years (the total time to paydown the mortgage w/ these extra payments).

Option 1: Paydown mortgage ($500/mo in extra contributions for 19 years)

Principal = $114,000

Return on investment (4%/yr) = $52,027

Net wealth increase: $166,027

Pros Cons
  • Mortgage fully paid off, no more payments
  • Saved more money than putting it in the bank
  • Only made $52k on $114k over a period of 19 years
  • No liquidity, all savings are now locked up into equity
    • Can only be unlocked by selling or taking another loan


So should you make additional mortgage payments? 19 years is a lot of time, let’s see what else you could do with that money over 19 years.

Option 2: Invest in the stock market

Principal = $114,000 ($500 investment per month)

ROI (8%/yr) = $134,677

Net wealth increase = $248,677

Now we’re getting somewhere, our investment itself is yielding much more each month ($1,650/mo) than the actual principal payments. But could we do better?

Option 3: Real estate – take out additional mortgage(s)

Let’s say that we’ve been using these funds consistently to get us to our 10 property max # of mortgages. For the sake of being conservative I’ll use 15% even though my first two properties are currently in excess of 30% annual returns.

Principal = $114,000 ($500 investment per month)

ROI (15%) = $415,270

Net wealth increase = $529,270

Pros: Cons:
  • Substantially higher return than the mortgage pay down or stock market options
  • Return on your investment paid monthly via rent checks – 100% liquid
  • Gives you experience in real estate investing so you can start building your empire
  • Real estate sounds scary – a lot of people hear it and think they will be spending all day fixing toilets
  • Leverage works both ways, buy a bad property as a result of not doing enough due diligence and you’ll have a big headache.


In summary:

In this scenario you would be 3X better off (and almost $100k richer) investing your additional mortgage payments into the stock market instead.

If you think instead of using leverage to acquire more properties rather than worrying about your current mortgage your return will be 8x higher. This results in $363k more wealth than you would have with monthly mortgage payments.

Still want to payoff that pesky mortgage? Use your returns from option 2 or 3 to do that, and still have your $114k principal to continue investing with.


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