When I look at a small amount like $100 and wonder whether to apply it toward paying down a mortgage or investing it in a mutual fund, I know the answer depends on several factors — your financial goals, interest rates, risk tolerance, and timeline. In this article, I’ll explore this choice from multiple angles, with clear examples and calculations to help you decide what makes sense for you.
Table of Contents
The Basic Tradeoff: Debt Reduction vs Investment Growth
Paying down mortgage principal reduces your debt, thereby decreasing the total interest you pay over time. Investing in a mutual fund exposes your money to market growth but also market risk.
Let’s start by comparing these options mathematically.
Comparing Mortgage Paydown and Investment Returns
Suppose you have $100 extra each month to allocate either toward your mortgage principal or invest in a mutual fund. Assume:
- Mortgage interest rate = 4% annually (common US mortgage rate)
- Mutual fund average return = 8% annually (stock market average)
Paying Down Mortgage
Every extra dollar toward your mortgage saves you interest at your mortgage rate. So $100 extra payment reduces your mortgage balance and saves roughly 4% annual interest.
Investing in Mutual Funds
If you invest $100 instead, you might expect an 8% return but with risk and no guaranteed return.
Mathematical Illustration: Growth Over 10 Years
1. Mortgage Paydown Interest Saved
By paying $100 extra monthly toward your mortgage, you reduce your principal faster and save interest over time. The exact savings depend on your mortgage balance and amortization schedule, but roughly you save 4% interest on the $100 every year.
For simplicity, consider interest saved as:
Interest\ Saved = 100 \times 0.04 \times 10 = 40 dollars over 10 years (ignoring amortization nuances).
2. Investing $100 Monthly in Mutual Fund
Using the future value of an annuity formula with monthly contributions:
FV = P \times \frac{(1 + \frac{r}{m})^{nm} - 1}{\frac{r}{m}}Where:
- P = 100
- r = 0.08 (8% annual return)
- m = 12 (monthly compounding)
- n = 10 (years)
Calculate:
FV = 100 \times \frac{(1 + \frac{0.08}{12})^{12 \times 10} - 1}{\frac{0.08}{12}} = 100 \times \frac{(1.006667)^{120} - 1}{0.006667}Calculating powers:
(1 + \frac{0.08}{12})^{120} \approx 2.21964
So,
FV = 100 \times \frac{2.21964 - 1}{0.006667} = 100 \times 182.95 = 18,295So investing $100/month grows to about $18,295 in 10 years at 8%.
What This Means
- Paying down the mortgage saves approximately $40 in interest over 10 years on that $100 per month. This is a simplified estimate and actual savings are usually higher because you reduce principal over time.
- Investing the same $100/month can grow to $18,295, assuming an average 8% return, but with market risk.
Other Factors to Consider
- Mortgage Interest Deduction: In the US, mortgage interest may be deductible if you itemize, reducing effective mortgage cost.
- Risk Tolerance: Mortgage paydown guarantees a “return” at your mortgage rate with no risk. Mutual fund returns fluctuate.
- Liquidity: Investments are more liquid. Extra mortgage payments lock money into your home.
- Debt Level: If your mortgage rate is high (above 6-7%), paying it down may make more sense.
Summary Table: $100 Monthly Allocation Over 10 Years
| Allocation | Approximate Outcome | Notes |
|---|---|---|
| Mortgage Paydown | ~$40 interest saved | Guaranteed “return” at 4% |
| Mutual Fund Investment | ~$18,295 total growth | Higher return, market risk applies |
My View
If you have a low mortgage rate and emergency savings in place, investing $100 monthly in mutual funds can grow wealth faster over time. If your mortgage rate is high or you want guaranteed savings and debt freedom, paying down the mortgage is safer.
