This time last year, I decided to take my raise at work and put it all towards my mortgage. The idea was that I wouldn’t notice the reduction in pay because I’d be right where I was before I got it. And I’d pay off my mortgage a year early, save on interest to the bank and feel good about it. You can read about that decision here.

Annual raise time has come at work and I’m going to do the same thing I did a year ago, putting my increased salary towards my mortgage each month. Coincidentally, I’ve been talking to a number of people about mortgages this past week and in doing so have come across a number of different situations, all of which have different recommendations. So what I’m doing might not be the best approach for everyone.

So what do you do with a mortgage? Well, it depends! First off, what do you do before you get a mortgage? There are really 3 situations and let’s assume that you have 20% for a down payment. If you don’t I’d really recommend you save up for that. But here are the 3:

- You have exactly 20%
- You have more than 20%
- You have 100%

If you are buying a house that doesn’t come with income, like a rental property, your goal should be to reduce your costs and maximize your opportunity to earn money via other investments. This means that if you are incurring debt and have no money left over to invest, you should pay that sucker off as soon and as inexpensively as possible. But if you have the money to buy a house entirely and a bank will still loan you 80% of the cost at 3% or whatever, you can easily take that 80% you’re not spending on the house and go earn a 5% or a 10% return doing something else. $100,000 loaned to you at 3% means that you’ll own $3,000 (simplifying math here), but if you have $100,000 in cash, you can borrow another $100,000, pay $3,000 to the bank for it and then earn $5,000 in the market. You net $2,000. Again, simplifying math.

Here’s the recommendation:

- You have exactly 20%: Put down all 20% and buy a reasonable house with a 10 or 15-year mortgage.
- You have more than 20%: Put down only 20%, invest the rest and buy a reasonable house with a 10 or 15-year mortgage.
- You have 100%: Put down as little as possible while still getting a cheap interest rate, extend your loan for as long as you can. Invest your money.

#3 might seem a bit counter intuitive, but leverage is the key to growth. You’ll have money in the market and an equal amount being loaned to you at a low rate. Your house is also appreciating in value and you can always just pay it off with a single check. You might pay a few hundred thousand dollars in interest payments, but you’ll earn twice that in the market.

But what should you do if you are already in the midst of a mortgage? Here are 3 similar situations:

- You can’t afford to pay any more each month than you already do.
- You can afford to pay a little more each month, but not a large chunk at once.
- You can afford to pay a large chunk or the remainder of the mortgage at once.

Can you see where this is going? There are certainly some psychological and emotional benefits to paying off a mortgage early, but it might not be the best thing financially. That doesn’t mean you shouldn’t do it though! Just think about the options.

The important thing to keep in mind is that when you are already in a mortgage, paying it off a little more each month is likely better than saving a little each month and then investing a chunk. Let’s say you can pay $100 more each month: if you wanted to instead save it and invest it, you’d either pay $10 to buy $90 of stock or you’d wait a year and then pay $10 to invest $1,190. But you would have missed the opportunity to save the interest payments. If it’s not a lot of money each month, I’d recommend just putting it towards the mortgage.

What if you have a large chunk? Let’s say you have $100,000 and are thinking about paying down the mortgage. You could save 3% a year or could go make 5% a year–it’s the same principal as the situation where you have money and are getting a mortgage. Here’s what I recommend for the 3 situations:

- You can’t afford to pay any more each month than you already do: Cut your costs and start paying down the mortgage each month.
- You can afford to pay a little more each month, but not a large chunk at once: Start paying down the mortgage each month.
- You can afford to pay a larger chunk or the remainder of the mortgage at once: Take your extra money and invest it. Start paying down the mortgage each month with any extra cash flow.

Paying off a mortgage is usually a good idea. But it’s important to look at the cost savings on interest vs. the growth opportunity via a different tactic. For example, it’s better to defer 6% of your salary into your 401k and get a 100% match from your employer than it is to pay off a mortgage and save 3% on interest. Chances are that paying off a mortgage fast is one of the least effective ways to use your money. It’s still effective, don’t get me wrong, but be absolutely sure you aren’t passing up other great opportunities for better returns.

Think over your options and make sure you are taking advantage of all the government and employer benefits you can. If you still have some money left over, consider paying off your mortgage. It will feel pretty darn good when you are free from it.