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Pay Off Mortgage vs Invest

Got extra money? Pay down the mortgage or invest?

The mortgage
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$
Investment assumptions
%
Your tax situation (used for the “true” after-tax comparison)

Filing status

$
%
%
$
$
$

State taxes cap gains as ordinary income?

Most states tax LTCG as ordinary income. Exceptions exist (TX/FL/WA: no state tax; some have a separate cap-gains rate).

With $500/month extra

Invest

Investing the extra at 7% beats prepaying the 6.5% mortgage by $5,028 at year 25. After-tax spread: +0.30% in favor of investing. Caveat: this is the expected outcome. Investments are risky, prepayment is guaranteed.

Mortgage rate (after-tax)

6.00%

6.5% × (1 − 7.7% effective deduction value)

Market return (after-tax)

6.30%

7% taxed at 20.0% (15% LTCG + 5.0% state), gains deferred to year 25

Spread

+0.30%

investing favored

Mortgage paid off (prepay)

Mo 191

15yr 11mo

Net wealth at horizon

$5,028

invest path ahead

Net wealth over time (portfolio − mortgage balance)
Prepay path Invest path
-$298,974-$156,688-$14,401$127,885$270,171$412,457Yr 0Yr 5Yr 10Yr 15Yr 20Yr 25

How the after-tax rates are computed:

  • Mortgage: marginal-value method, benefit = max(itemized − max(standard, itemized−interest), 0) × marginal. If you’re under the standard-deduction floor, mortgage interest provides zero benefit. Only interest on the first $750k of balance counts (acquisition-debt limit). The loan itself amortizes at its note rate on both paths; the tax savings are a separate cash flow that gets invested as it arrives.
  • Investment: a taxable brokerage account. Assumes a 1.5% dividend yield taxed each year as qualified dividends; the rest of the return is price growth, taxed as a long-term gain only when you sell at the horizon (shown values assume you sell). Rate = LTCG bracket (0/15/20% by AGI) + NIIT (3.8% over $200k single / $250k MFJ) + state, if your state taxes cap gains as ordinary income. The after-tax return shown is for money invested today and held to the horizon.

What this still doesn’t model:

  • 401(k) match. Always take that first. It’s a 100% instant return you’ll never beat.
  • Tax-advantaged space. Investing in a Roth IRA or 401(k) avoids the LTCG/NIIT entirely; this calc assumes a taxable brokerage account.
  • Liquidity. Invested money is accessible; paid-off equity requires a HELOC or refi.
  • Sequence-of-returns risk. A bear market early in the horizon hurts the invest path more than the average-return assumption suggests.
  • Step-up basis at death. Heirs get cap-gains forgiveness on inherited investments, meaningful for older borrowers.
  • Deduction decay. Mortgage interest declines each year as you amortize, eventually falling under the standard-deduction floor for some borrowers. The calc uses year-1 interest to set the deduction’s value per dollar of interest throughout.

For a precise after-tax mortgage rate alone, see the Mortgage Interest Deduction calculator.