- Should I Pay Off My Mortgage Or Invest The Extra Cash?
- Pay off your mortgage early
- Invest in the stock market
- You have a lump-sum of cash. Should you pay off your mortgage or invest?
- How to pay offyour mortgage early
- What toconsider carefully before investing or paying extra on your mortgage
- Do I have an emergency fund?
- Is there other higherinterest debt I should pay off first?
- Will paying off my mortgage early affect income taxes?
- Alternative option: Refinance your mortgage and invest
- Should you pay off your mortgage early or invest? We did the math to find out which nets a greater return
- The hypothetical
- The calculation
- Should You Pay Off Your Mortgage Early, Before You Retire?
- A middle ground
- Pay Off Your Mortgage Early Vs. Investing: Which Is Best?
- Pay Mortgage Early or Invest: What Does the Math Say?
- Reasons to Pay Your Mortgage Early vs. Invest
- Benefits of Paying Off Your Mortgage Early
- Drawbacks of Paying Off Your Mortgage Early
- Benefits of Investing Your Extra Cash
- Drawbacks of Investing Your Extra Cash
- Best of Both Worlds: Refinance and Invest
Should I Pay Off My Mortgage Or Invest The Extra Cash?
Maybe you have some extra cash thanks to a bonus or raise. Maybe you recently inheriteda big sum ofmoney.
What’s the best way to put those dollars to work?
Should you pay extra on your mortgage to shorten yourloan term and save on interest? Or should you invest in the stock market and build up your retirement accounts?
Or, should you doboth: refinance to save on your loan and invest the rest to see bigger returns?
The right answer depends on your tolerance for riskand your long-term goals.
Check your mortgage options (Mar 26th, 2021)
In this article (Skip to…)
Let’s take a look at one example to demonstrate the difference between paying off a mortgage early and usingthe same money to invest.
Say you recently got a raise. You now have an extra$2,000 coming in each month.
What happens if you use that extra money to make early mortgage payments?
Pay off your mortgage early
“Assume you bought a house for $250,000,” says Katsiaryna Bardos, associate professor of finance at Fairfield University.
- Youborrow $200,000 using a 30-year mortgage loan
- Yourfixed interest rate is 3.25%
- Yourmortgage loan payment is $870 per month (not includingtaxes and insurance)
- You’dpay $113,350 in interest over 30 years
“But if you make additional $2,000 payments everymonth,” explains Bardos, “you’d pay off your mortgage in 6½ yearsand will only pay $21,900 in interest over that time.”
- Your total interest savings wouldbe $91,400
That’s a huge amount of money back in your pocket.
However, this example assumes you stay inthe house for your complete loan term and pay the loanoff in full — which most homeowners don’t do.
So let’s see how the returns compare if you invest the $2,000 each month instead of paying extra on your mortgage.
Invest in the stock market
History shows that other investments can yield abetter annual return than the interest rate you are ly payingon your mortgage.
“The historical rate of return on the stock market isaround 8%,” Bardos says. She gives thisexample:
- Instead of paying extra on themortgage, you choose toinvest that $2,000 every month for 6½ years
- Assumeyou earn an 8% annual rate of return
- If so,you’d earn $203,700 – which is about $112,300 more than the $91,400 you’dsave by prepaying your mortgage
For manyyears now, interest rates on mortgages have stayed well below the average returns ofthe stock market.
That means you’d ly earna better return byinvesting than you’d save by paying off mortgage interest early.
“From a purely financial perspective, it can generally make more sense to contribute any extra money you receive toward your investments rather than paying off your mortgage early,” says Anna Barker, personal finance expert and founder of LogicalDollar.
However, your investment’s better rateof return is not guaranteed; you could lose money investing in stocks or bonds.
“If you have a fixed-rate mortgage, investing in your home is a sure thing — you know exactly how much money you will save in interest,” notes Elizabeth Whitman, attorney and managing member at Whitman Legal Solutions, LLC.
So when you decide how to use your hard-earned cash,you also have to consider your personal risk tolerance.
If you’re not confident making the decision on your own, speak to a financial advisor or a certified financial planner to see what makes the most sense for you.
You have a lump-sum of cash. Should you pay off your mortgage or invest?
Here’s a different scenario: An older relative passesaway and you inherit $100,000 after taxes.
You debate whether it’s smarter to direct the wholelump-sum toward your mortgage or put it into stocks or retirement savings accounts.
Using the previous example, let’s sayyou pay down your mortgage by $100,000 during your first month of borrowing$200,000 total.
- Inthis example, you’d pay a total of $20,300 in interest for a total savings of $93,000
“Your mortgage would be paid off in 11½ yearsinstead of 30,” explains Bardos.
- Alternatively,you choose to invest the $100,000 in stocks that yield an 8% return over 11.5years
- Using these metrics, you wouldearn $243,900
Whitman cautions that putting all that money intoyour home isn’t necessarily a good idea — especially if the home is your only investment.
“You should have several types of investments, such as stocks, bonds, and real estate, so that your portfolio is diversified,” says Whitman.
“That way, if the stock market goes down, there’s achance you won’t lose as much money if, say, the real estate and bond marketsremain steady.”
Assuming your rate of return will be favorable,investing some or all of that $100,000 into yourretirement plan maybe your best bet.
“With an IRA, 401(k), or similar investment, you can invest the money using pre-tax dollars. Plus, you don’t pay tax on the money until you withdraw it,” Whitman suggests.
How to pay offyour mortgage early
If you want to pay off all or part of your mortgage early, there are a number of ways to do so.
Devoting extra dollars toward your mortgage in theform of accelerated payments can be a great way to save money.
This tactic can reduce the amount of interest that accrues by thousands of dollars over the life of your loan. It can also shorten your loan term by several years.
- Withaccelerated payments, you send extra money to your lender or loan servicer onceor more each year
- You shouldindicate these additional dollars must be appliedtoward your principal (not future interest)
- Thisstrategy will decrease the interest that accrues on your mortgage in thefuture, reducing your loan’s term and enabling you to pay off yourloan more quickly
“By either making more than the minimum repaymentamount each month or making more frequent payments, you can reduce the loanprincipal faster,” says Barker.
“This, in turn, will mean that the overall amount youowe will continue to be reduced more quickly than initially expected, as lessinterest will be applied on the now-reduced principal.”
You can make accelerated payments by either:
- Payinga little more than your monthly payment each month
- Makingbiweekly payments (26 smaller payments a year instead of 12), or
- Makingone extra payment annually (13 total payments instead of 12)
But prepaying your mortgage via one of these options may not be your best financial decision. Many homeowners are ly to earn a higher rate of return on their money by investing it.
Check your mortgage options (Mar 26th, 2021)
What toconsider carefully before investing or paying extra on your mortgage
The right choice for you will depend on your financial situation and how much risk you are willing to take on.
“Paying off your mortgage is essentially a risklessinvestment. You know how much you will save right up front,” says Bardos.
“Most other investments with higher returns areassociated with higher risks. You can and may lose money. So consider youroverall portfolio, risk appetite, and time horizon when making investmentdecisions.”
Askyourself a few questions beforepursuing either option:
- Does your mortgage allow for easy repayment? Or is there a penalty for prepaying your loan? “This may sway you either way if there’s a cost involved that may not make early repayment worthwhile,” says Barker. Note, the vast majority of mortgages taken out since 2014 do not charge prepayment penalties
- What are your financial goals? “Investing the money may make more sense from a financial perspective. But if you are uncomfortable with the amount of debt you are carrying, putting even some of this toward your mortgage could help you sleep better at night,” Barker points out
- Are you comfortable investing this much at once? “Depending on how the market is performing, your risk appetite, and your overall investment strategy, investing any extra money you have all at once may not work for you. In this case, you may prefer to put some of the money toward your investments and the rest toward your mortgage,” Barker advises
There’s achance that neither paying off your mortgage nor investing in the stock marketis your best option.
Depending on your financial situation, there could be other smart uses for your dollars. Consider:
Do I have an emergency fund?
There areplenty of scenarios where emergency savings come in handy. What if you lostyour job or fell ill and couldn’t work? What if you faced a major car repair orneeded to move unexpectedly?
You’dneed some extra cash. That’s why so many financial advisors recommend keepingan emergency fund in your savings account. The size of your cash reserve is upto you, but most experts suggest keeping enough money to pay for up to 6months’ living expenses if necessary.
Puttingall your extra cash into your mortgage wouldn’t leave you much flexibility tocover unexpected needs. You’d need a home equity loan to liquidate your realestate asset.
You couldliquidate stock investments more easily, but you may face early withdrawalpenalties and income tax implications for pulling money retirementaccounts.
Somepeople end up using credit cards to address the emergency and then pay highinterest rates on those revolving balances.
Is there other higherinterest debt I should pay off first?
Eitherinvesting or paying off a mortgage could be short-sighted if you’re saddledwith a lot of high-interest debt.
When youowe $20,000 in credit card debt at 20% interest, for example, you’re paying$4,000 a year in finance charges. For most homeowners, paying off thishigher-interest debt first could unlock more savings than you’d earn investing.
In this case, you may want to consider a cash-out refinance or a home equity loan to use the value in your home to pay off high-interest credit card debt.
Thesekinds of loans are one of the perks of homeownership — assuming you’ve built upenough equity to borrow against.
Studentloans tend to charge lower amounts of interest; the average American pays lessthan 6% on student loan balances. So using a home equity loan to consolidatestudent loans makes less sense.
Will paying off my mortgage early affect income taxes?
Becoming debt-free is a goal for a lot of people for good reason. With no mortgage debt, you can better control how you spend your hard-earned cash. Plus, you have extra peace of mind knowing you own a large asset.
But mortgage debt can have its own advantages, too. For example, some homeowners write off their mortgage interest on their income tax returns each year. Some borrowers can even write off the cost of mortgage insurance premiums.
Mortgageinterest is tax-deductible only if you itemize your tax deductions. And you typicallyshouldn’t itemize deductions unless they exceed the IRS’s standard deduction.
Payingoff the mortgage debt would eliminate this tax deduction for those who claim it— and losing any deduction could bump you into a higher tax bracket. Paying ahigher tax rate would impact your bigger financial picture.
Talk to a professional tax advisor if you’re not sure about the best way to handle your income taxes. We’re not tax experts after all, and this site does not give tax advice.
Alternative option: Refinance your mortgage and invest
Maybe you don’t have to decide between saving on yourmortgage and investing in the stock market.
There’s a third option to consider: Refinancing to save money on your home loan and putting therest of your cash into higher-yield investments.
You may be able to accomplish both goals — paying off your mortgage early and earning returns — if you refinance into a shorter loan term.
However, shorter mortgage terms mean larger monthly payments.So you might not have much cash leftover if you do that.
You could also refinance to a new 30-year mortgagewith a lower rate.
With today’s near-record low mortgage rates, youcould still save a substantial amount on your overall mortgage interest andhave money left over to invest.
Beforerefinancing, make sure your credit score qualifies you for a low interest rateand shop around with at least three different lenders to find the best deal.
Know what your financial goals are, explore youroptions, and make sure you’re choosing the best strategy to get you there.
Verify your new rate (Mar 26th, 2021)
Should you pay off your mortgage early or invest? We did the math to find out which nets a greater return
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Debt can often be a thorn in your side on the path to building wealth, but it's not all bad.
Still, if you're a homeowner with a mortgage, you've ly weighed the decision to pay it off early, if you can afford to. It's a worthy goal to be free and clear of all debt, but is it the right choice if you're trying to optimize your every dollar?
We consulted Brian Fry, a certified financial planner who founded Safe Landing Financial. He said the answer really depends on the specifics of the situation, but generally the biggest factor in deciding whether to pay off a mortgage early or invest your extra cash from a windfall, salary raise, or some other source is the interest rate.
Here are his high-level recommendations. Scroll down for the full set of assumptions he used.
- Best action: Refinance and invest more aggressively, because a 15-year fixed mortgage with a rate of 2.33% is much lower than the market's expected rate of return.
- Second-best action: Refinance and pay the mortgage aggressively. If the homeowner doesn't agree with long-term investment-return estimates and would rather act more conservatively, they can pay off the mortgage and then invest and still come out OK.
- Third-best action: Don't refinance and pay the mortgage more aggressively. The homeowner will be debt-free 100 months sooner by putting an extra $24,000 a year toward the loan balance.
- Worst action: Don't refinance, don't invest, and spend the extra cash instead. If the homeowner did not refinance and decided to spend the money, they would not have extra retirement savings, if that's their goal.
- Second-worst action: Don't refinance, and still invest the extra cash. A 6.15% interest rate you may have locked in year ago on your loan is higher than the market's expected rate of return. If the homeowner is locked into a higher interest rate, it's best to pay off the debt first.
If the rate on your mortgage is higher than what you might make by investing the cash, it's often better to pay down your debt before investing more, Fry said.
That is, unless you consider refinancing to secure a lower rate, he said. In fact, refinancing can be a good option whether or not you ultimately decide to pay your mortgage aggressively. Interest rates fluctuate and they're currently at historic lows, so be sure you shop around before making a decision or running your own numbers.
But Fry said it's also crucial to look at how far you are from retirement, how long you plan to stay in the home, whether you have other high-interest debt, the possibility of tax deductions, and the status of your emergency fund and retirement savings. There are non-financial factors to think about as well.
“It's really important to have a good understanding of what you're trying to accomplish before determining the best course of action,” he said. And if you need help, a fee-only financial planner can be a great resource, he said.
To help illustrate the debate between paying off your mortgage early versus investing, we asked Fry to run a simulation. Below are the assumptions he used:
A homeowner just got a raise that will net them an additional $24,000 a year after taxes. They plan to stay at this job, and it's unly they'll get any more raises or cost-of-living adjustments. (This figure was used for the purposes of this calculation; a smaller raise or windfall would yield similar results.)
They have an established emergency fund and no other debt, and they're already maxing out their 401(k) and IRA. They plan to stay in their home forever and retire in 15 years, at 65.
Their initial mortgage balance was $400,000 on a 30-year fixed-rate loan they got in 2006 with an interest rate of 6.15%. They are 15 years into their mortgage and have a remaining balance of $285,058.
If they refinance to a 15-year fixed mortgage, their interest rate would be 2.60%. Refinancing costs are estimated to be $6,000, for simplicity. Generally, refinancing costs are 1.5% to 4% of the remaining mortgage balance.
Their nest egg is diversified, and they are looking to make the best financial decision about how to use the extra income to maximize their wealth. Do they use this extra money to pay off their mortgage more aggressively, or invest more aggressively?
Fry used Right Capital, a financial-planning software, to calculate how much the homeowner would have in a taxable investment account in 15 years using a straight-line analysis.
The variables are whether they refinance their mortgage, and whether they put their additional income (and savings from refinancing, if available) into an investment fund or put it toward their loan balance.
Fry used the Vanguard Total Stock Market Index Fund, which has a long-term annual return of 5.38%, according to JPMorgan estimates. He said it's important to remember that the market doesn't go up by the same percentage every year: Some years offer better returns, while others may have negative returns.
Invest more aggressively:
- If the homeowner refinances their mortgage and invests what they save on monthly payments plus $24,000 a year, in 15 years they will have paid off their mortgage and have an investment-account balance of $616,641.
- If the homeowner does not refinance their mortgage and invests the $24,000 a year, in 15 years they will have paid off their mortgage and have an investment-account balance of $489,592.
Pay mortgage more aggressively:
- If the homeowner refinances their mortgage and uses the amount they save on monthly payments plus the $24,000 additional income to pay it down more aggressively and then invest, in 15 years they will have paid off their mortgage and have an investment-account balance of $580,660.
- If the homeowner does not refinance their mortgage and uses the $24,000 additional income to pay it down sooner and then invest, in 15 years they will have paid off their mortgage and have an investment-account balance of $531,355.
Should You Pay Off Your Mortgage Early, Before You Retire?
Some people enjoy the peace of mind that comes with a debt-free retirement. But warm and fuzzy feelings should be weighed against solid financial facts.
When it comes to paying off your mortgage, for example, first take a look at the interest rate.
“If the rate on your mortgage is low, you might be better off holding onto your cash—or even investing it, assuming you’re reasonably confident you can get a higher rate of return than you’re paying on the loan,” says Rob Williams, vice president of financial planning at the Schwab Center for Financial Research. “But, at the same time, reducing debt, and ideally eliminating it, all else equal, should be on your list of goals before retirement.”
With interest rates are at a record low, including sub-3% mortgage rates, it may be tempting to refinance a mortgage or not pay it off.
But it’s worth keeping in mind, that it's hard to get a 3% guaranteed investment return from any investment today. Being “reasonable confident” you get a higher rate of return involves risk.
It’s important to evaluate your risk tolerance before making a decision.
Here are the pros and cons to consider before retiring a home loan.
- Limited income: Your monthly mortgage payment may represent a significant chunk of your expenses. Eliminating it can greatly reduce the amount of cash required to meet monthly expenses.
- Interest savings: Depending on its size and term, a home loan can cost thousands or even tens of thousands of dollars over the long haul. Paying off your mortgage early frees up that future money for other uses. While it’s true you may lose the mortgage interest tax deduction, the savings on servicing the debt can still be substantial. Besides, the closer you get to paying off the loan, the more of each monthly payment goes to principal, decreasing the amount you can deduct.
- Predictable return: Investments can go up—and they can go down. But no longer paying interest on a loan can be earning a risk-free return equivalent to the mortgage interest rate. Being relatively confident of earning a return that exceeds the mortgage rate is not the same thing as being certain of earning that rate. There's a risk of loss too.
- Peace of mind: Numbers aren’t everything, so if you’re determined to retire your mortgage, consider tapping taxable accounts first. “If you withdraw money from a 401(k) or an individual retirement account (IRA) before 59½, you’ll ly pay ordinary income tax—plus a penalty—substantially offsetting any savings on your mortgage interest,” Rob says.
- Insufficient retirement savings: If you aren’t contributing enough to your 401(k), IRA or other retirement accounts, this should probably be your top priority. Savings in these accounts grow tax-deferred until you withdraw them.
- Insufficient cash reserves: Rob recommends keeping a cash reserve of three to six months’ worth of living expenses in case of emergency. “You don’t want to end up house rich and cash poor by paying off your home loan at the expense of your reserves,” Rob says.
- Higher-interest debt: Before you pay off your mortgage, first retire any higher-interest loans—especially nondeductible debt that from credit cards.
- Opportunity costs: One way to determine if investing the funds is preferable to paying off your mortgage is to compare your mortgage interest rate to the after-tax rate of return on a low-risk investment with a similar term—such as a high-quality, tax-free municipal bond (assuming the issuer is from your home state. You may have to pay taxes on out-of-state municipal bonds). If your mortgage is costing you less than you’d earn, you might consider keeping it.
- Diversifying your investments: Maintaining your mortgage allows you to hold more of other asset classes. And overconcentration carries its own risks—even when it’s in something as historically stable as a home.
A middle ground
If your mortgage has no prepayment penalty, an alternative to paying it off entirely is to chip away at the principal. You can do this by making an extra principal payment each month or by sending in a partial lump sum.
This tactic can save a significant amount of interest and shorten the life of the loan while maintaining diversification and liquidity. But avoid being too aggressive about it—lest you compromise your other saving and spending priorities.
You could also consider refinancing. Current interest rates are relatively low, and depending on the type of loan you have, refinancing might make sense for you.
If this is something you’re interested in pursuing, make sure you do a thorough cost-benefit analysis before pulling the trigger. If you refinance, though, avoid the temptation to take out more equity, or increase your debt.
The goal, ideally, should be to reduce debt on your primary home over time—not increase it.
Pay Off Your Mortgage Early Vs. Investing: Which Is Best?
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Though you may be a proud homeowner, you probably don’t love the thought of having to make a mortgage payment each month for the next few decades. But considering how well the stock market has been performing lately, it might feel you’re missing out by not investing more.
So what’s the right answer: Should you pay your mortgage early or invest your extra funds? Here’s what you should know to help you make a decision.
Pay Mortgage Early or Invest: What Does the Math Say?
You probably dream of the day when you no longer have a mortgage payment hanging over your head. Being debt free is an admirable goal, but it might not make the most sense financially. Especially now, with mortgage rates so low, it’s cheap to hold debt. That leaves the opportunity to grow your wealth more through other investments.
Let’s take a look at an example. Say you have a 30-year mortgage of $200,000 with a fixed rate of 4.5%. Your monthly payments would be $1,013 (not including taxes and insurance), according to our mortgage calculator, and you’d spend a total of $164,813 in interest over the life of the loan.
Now let’s say that you’re able to come up with an extra $300 per month to put toward your mortgage. You’d shave off 11 years and one month from your repayment period, plus save $67,816 in interest.
On the other hand, you could take that $300 per month and invest it in an index fund that tracks the S&P 500 Index instead. Historically, the S&P 500 has returned an average of 10% to 11% annually since its inception in 1926 through 2018. If you want to be extra conservative, however, we can assume an average annual return of 8% on your investment.
At the end of 19 years (about the length of time it would take to pay your mortgage early), you would have $160,780. That’s more than double your potential interest savings. In fact, after that length of time, you’d have about $105,487 left on your mortgage. If you decided to pay your mortgage early after all, you could use your investment funds and still have $55,293 left over.
Reasons to Pay Your Mortgage Early vs. Invest
From a financial perspective, it’s usually best to invest your money rather than funneling extra cash toward paying your mortgage off faster. Of course, life isn’t just about cold, hard numbers. There are many reasons why you might choose either to pay your mortgage early or invest more.
Benefits of Paying Off Your Mortgage Early
- Interest savings: This is one of the biggest benefits of paying your loan off early. You could save thousands or tens of thousands of dollars in interest payments. When you pay your mortgage early, those interest savings are a guaranteed return on your investment.
- Peace of mind: If you don’t the idea of constant debt, paying your mortgage early could ease your burden. If you experience a financial emergency, having a home that’s already paid off means you don’t have to worry about missing mortgage payments and potentially losing the home to foreclosure.
You still will be responsible for property taxes as long as you own the home, but that’s a much smaller financial responsibility.
- Build equity: Paying down your mortgage faster means building equity in your home more quickly. This can help you qualify for refinancing, which can save you even more money in the long run.
You may also be able to leverage your equity in the form of a home equity loan or home equity line of credit (HELOC), which you can use to make improvements that increase your home’s value or pay off other higher-interest debt.
Drawbacks of Paying Off Your Mortgage Early
- Opportunity cost: Any extra money you spend on paying down your mortgage faster is money you aren’t able to use for other financial goals. You may be paying off your mortgage early at the expense of your retirement savings, emergency fund or other higher return opportunities.
- Wealth is tied up: Property is an illiquid asset, meaning you can’t convert it to cash quickly or easily.
If you faced a financial emergency or had an investment opportunity you wanted to jump on, you’d not only have to sell your house, but also wait until a buyer was available and the sale closed.
- Loss of some tax breaks: If you choose to pay down your mortgage instead of maxing out your tax-advantaged retirement accounts, you will give up those tax savings. Plus, you may lose out on tax deductions for mortgage interest if you normally itemize.
Benefits of Investing Your Extra Cash
- Higher returns: The biggest benefit of investing your money instead of using it to pay down your mortgage faster is the ROI.
For many years, average stock market returns have been significantly higher than mortgage rates, which means you stand to gain quite a bit from the difference.
- Liquid investment: Un a home that ties up your wealth, having your money in stocks, bonds and other market investment means you can easily sell and access your money if you need to.
- Employer match: If you choose to invest your extra funds in a retirement account and your employer offers a match, that’s additional free money that you get to enjoy compound earnings on over time. You’d also be investing pre-tax dollars, which could help you afford larger contributions.
Drawbacks of Investing Your Extra Cash
- Higher risk: There is more volatility in the stock market than in the housing market year over year, so you should be sure your investing timeline is long enough to weather ups and downs.
You also need to make sure that your investment strategy matches your risk tolerance and you’re mentally prepared to take some hits.
- Increased debt: Choosing to invest your money may not be the best option if you don’t the idea of having debt to your name.
Until your mortgage is repaid, you don’t actually own your home—the bank does. And there will always be some risk that you could lose your home if you aren’t able to make the payments.
Best of Both Worlds: Refinance and Invest
If you’re still on the fence about which option is best, you may not need to choose between paying your mortgage early and investing. Rather, you can take a two-pronged approach to reducing your debt and growing your wealth.
Mortgage rates are at historic lows, which means it’s a great time to refinance.
If you took out your mortgage or last refinanced years ago, it’s ly that you can save quite a bit of money by refinancing to a lower interest rate and/or reducing your mortgage term length.
That’s true whether or not you also choose to pay down the loan more aggressively. Just be sure to factor in closing costs when running the numbers.
With your newfound mortgage savings in place, you can go ahead and invest, too. This allows you to spend less on your mortgage overall while still taking advantage of the higher returns of the stock market.