So, you’ve come into some extra money, possibly an inheritance windfall or a raise in pay. And while you want to spend it on a new hot tub, you’re determined to make a more prudent financial move. Should you put that extra money toward paying down your mortgage, or should you invest it?

While either one (or even a little of both) can be considered a smart move, when we look at it from a purely financial standpoint, many experts believe that in most cases, investing generally has the advantage. When interest rates were very low, the answer was straightforward: low borrowing rates usually mean it makes more sense to invest, because the rate of return on investments should be higher over the long term. However, as interest rates have risen several percentage points in the past year, the answer to the question is less obvious. If the rising interest rates means higher mortgage payments for you, is it still better to invest than pay down a mortgage?

Well, like many things in life, the answer is: it depends. On your personal financial situation, your age, your attitude toward money, interest rates, inflation rates, and a whole host of other things. But if you’re trying to decide, we’ve weighed out some pros and cons of both scenarios.

Why put extra cash toward your mortgage?

• Pay less interest.  Reducing your mortgage principal by making extra payments early on can save you thousands of dollars in interest that you would have had to pay on a higher principal.
• Build home equity. The less you owe on your mortgage, the more equity you can access from your home, which can be leveraged for things like a home equity loan/line of credit to make improvements , or to pay down your other higher-interest debt.
• Free up money for other things. If you’re mortgage free faster, your mortgage payments end. Now you can use that money for other things, including investments. 

Disadvantages of putting extra cash toward your mortgage

• Low liquidity. Your house, while valuable, is not a liquid asset. You can’t easily convert it to cash in a financial emergency.
• Putting all your eggs in one basket. If your mortgage is your only financial investment, you could be neglecting other key elements in your financial health, such as retirement savings or an emergency fund.
• Prepayment penalties. Many mortgages restrict the amount you can pay down your principal each year and/or the number of extra payments you can make. Be sure to understand your limits before making an extra payment.

Why invest your extra cash?

• Compounding effect. Putting extra cash toward your investments lets you enjoy the benefits of compounding for longer.
• Potential for higher returns. Historically, average stock market returns have been higher than mortgage rates, which means you may earn more on your investments over the long term.
• More liquidity. If you put your extra cash into your mortgage, it’s tied up in your home. Money you invest tends to be more liquid, depending on the individual investment, which means you may be able to more easily cash in the investment to access your money if you have to.
• Tax advantages. Contributions to your RRSP are tax deductible from your income, and in both RRSPs and TFSAs, your investment earnings can grow tax free while in the account. Once you remove the funds from an RRSP, they become taxable earnings. When you remove funds from a TFSA, you don’t have to pay taxes on the amount withdrawn, but investment earnings will no longer grow tax free. Just make sure you’re contributing to both within your contribution limits. You can find your TFSA and RRSP limits by logging into the Government of Canada’s My Account.
• Group retirement benefits. If your employment benefits include an RRSP matching program, putting extra cash into your group plan could increase your overall contributions.

Disadvantages of investing your extra cash

• Greater risk. Although historically stock markets have performed better than mortgage rates, past performance is no guarantee of future performance.
• No reduction in debt. For some, the concept of debt is difficult, especially one that usually amortized over 25 or 30 years. If having a mortgage feels like you have something hanging over your head for years, then putting your extra cash in investments won’t be helping to rid you of your debt.

Risk tolerance is another factor that could impact your decision. Over the long term, investments can fluctuate in value, which can significantly impact your return. The more risk in an investment, usually the higher the potential for reward, but you can also lose your money. If you are uncomfortable with risk, you’ll be more comfortable paying down your mortgage over investing in the stock market.

Why not do both?

You could decide to hedge your bets and do both – pay down your mortgage and invest toward your retirement at the same time. It all depends on your circumstances and preferences. If your mortgage rate is high – higher than you would expect to earn on investments – you may want to prioritize paying down the debt. But if you’re relatively young, and have decades until retirement, you don’t want to sacrifice your long-term, compounding investment returns in favour of your mortgage. Balance is key, and a compromise lets you make progress toward both goals.