Pay Off Mortgage or Invest with 3% Inflation? Do the Math

What pros do differently when rates feel ‘meh’ and inflation sits near 3%

When rates feel… meh, and inflation hangs near 3%, pros don’t default to “kill the mortgage” or “buy the dip.” They run the math like a portfolio manager. Quick framing: compare the after-tax cost of your mortgage to the risk-adjusted return of what you’d do instead, and, this matters, do it in real terms. If inflation is ~3%, fixed mortgage payments get cheaper in real dollars over time, which quietly improving standards for prepaying. I’ve messed this up before, paid extra on a 2.9% fixed when my equity sleeve was screaming cheap during a drawdown. Not my finest allocation moment.

What will you get here? A simple, repeatable checklist. We’ll stack-rank uses of cash, translate your loan’s nominal rate into a real after-tax hurdle, talk about how much risk premium to demand from investing, and match the time horizon to the asset. No heroics, just pro blocking-and-tackling.

Two quick reality checks to anchor 2025: per Freddie Mac’s Primary Mortgage Market Survey, 30-year fixed quotes have sat in the mid-6% to low-7% range this fall (Q3 into October). Meanwhile, BLS headline CPI has run roughly ~3% year-over-year for much of this year. Those two lines alone change the calculus. A 6.75% mortgage with ~3% expected inflation feels more like ~3.75% in real terms before taxes. If you itemize and deduct interest (not everyone does, standard deduction is still big, and SALT limits bite), your after-tax, real cost can be even lower.

Here’s the pro workflow I use with clients (and myself, when I’m not being stubborn):

1. Stack-rank cash uses:
   • Emergency fund (3-6 months expenses; 6-12 if income is volatile)
   • High-interest debt (anything with double-digit APR goes first, no debate)
   • Employer match (it’s a 50-100% instant return, hard to beat)
   • Tax-advantaged accounts (401(k), HSA, IRA, backdoor if needed)
   • Then: mortgage prepay vs. taxable investing
2. Think in real terms: real mortgage cost ≈ nominal mortgage rate − expected inflation. Example: 6.75% rate − 3.0% inflation ≈ 3.75% real cost.
3. Adjust for taxes: if interest is deductible for you, after-tax rate might drop from 6.75% to, say, ~5.0-5.5% depending on bracket and itemizing. Real after-tax ≈ that number − inflation.
4. Demand a risk premium: your expected investing return should exceed your after-tax mortgage rate by a margin that compensates for volatility. I like a 2-3 percentage point buffer for equities.
5. Match horizon to asset: short horizon (≤5 years) favors guaranteed debt reduction; long horizon (10+ years) can favor equities.

Quick test: If your real, after-tax mortgage cost is ~3% and your long-run equity expectation is ~6-7% real, you have a margin. If your horizon is short or your risk tolerance is thinner than you admit (been there), prepay looks better.

And context so you’re not flying blind: U.S. large-cap stocks have returned about 10% per year nominal and ~7% after inflation over 1926-2024 (Ibbotson/Morningstar data). That’s the historical average, returns are lumpy, and the “risk premium” shows up unevenly. Which is exactly why pros insist on a spread above the after-tax mortgage rate before shifting dollars out of a sure thing. One last note: with inflation near 3% this year, the real burden of a fixed mortgage keeps melting a bit each month. That doesn’t mean never prepay, it means you set a higher bar, on purpose.

The quick math pros use: breakeven in 90 seconds

You don’t need a 20-tab model here. You need a quick checklist and a gut check. Ballpark gets you 90% there; if it’s close, then you sharpen the pencil. Here’s the fast path I use on the desk and, yeah, in my own mortgage spreadsheet that’s way uglier than it needs to be.

1. After-tax mortgage rate ≈ stated rate × (1 − marginal tax benefit of interest). If you don’t itemize, the tax benefit is zero. Full stop. If you do itemize, only the interest that pushes you above the standard deduction and survives the $10,000 SALT cap (still in place through 2025 under TCJA) counts as a benefit. Many households lost the mortgage interest deduction after 2018 because they no longer itemize, worth remembering.
2. Expected real return = expected nominal portfolio return − expected inflation. Then compare that to the real cost of your mortgage (after-tax rate − expected inflation). We’re using real vs. real to avoid inflation noise. With inflation running around ~3% this year, the spread math actually matters more than people think.
3. Rule of thumb: if (expected after-tax nominal portfolio return − after-tax mortgage rate) is less than ~1-2%, prepay looks better. If it’s >2-3%, investing usually wins. In the mushy middle, you can split the baby: some prepay, some invest. I do that sometimes when my confidence isn’t high.
4. Time-in-loan matters. Earlier in the amortization, every extra dollar knocks out more future interest because your balance is bigger. On a $400k 30-year at 6.75%, the first-year interest is roughly $26-27k (payment about ~$2,595/month by standard amortization math). A $10k prepayment early on trims a chunk of that compounding interest path. Later in year 20? The interest portion is smaller; prepaying saves less.
5. Use scenario bands, not a single return. I like good/base/bad to avoid false precision: say 11%/8%/5% nominal for a 70/30-ish portfolio, which lines up with long-run U.S. data where large-cap stocks have averaged ~10% nominal and ~7% real over 1926-2024 (Ibbotson/Morningstar). Then subtract your inflation assumption (~3%) to get real 8%/5%/2%.

Quick example (approximate, not gospel): You’ve got a 6.75% mortgage. You don’t itemize, tax benefit = 0, so after-tax mortgage rate ≈ 6.75%. Your base-case nominal portfolio return is 8% with 3% inflation, so 5% real. Mortgage real cost ≈ 6.75% − 3% = 3.75% real. Nominal spread = 8% − 6.75% = 1.25%. That’s inside the 1-2% prepay-favoring zone. Prepay starts to look good, especially early in the loan. In a “good” scenario (11% nominal), the spread is 4.25%, that usually tilts to investing. In a “bad” 5% nominal year string, your spread is negative, prepay hands down.

One more wrinkle I see people miss: if you do itemize and your marginal federal+state bracket gives you, say, a 24% marginal benefit on the incremental interest, then your after-tax mortgage rate is 6.75% × (1 − 0.24) ≈ 5.13%. Now your nominal spread vs. an 8% expectation is ~2.9%. That’s in the “investing usually wins” bucket, unless your horizon is short (≤5 years) or you just sleep better with less debt. Both are valid. I’ve chosen the sleep option before heading into a job change.. no regrets.

Checklist to keep by the keyboard: (1) Do I itemize above the standard deduction this year? Yes/No. (2) After-tax mortgage rate = rate × (1 − marginal tax benefit). (3) Real return = nominal − inflation. (4) Compare real-to-real and nominal-to-nominal; look for a 2-3% cushion. (5) Where am I in the amortization? Early favors prepay. (6) Run good/base/bad, not a single number. If the answer’s still tight, split funds or revisit in six months.

Reality check on taxes in 2025: deductions, caps, and what might sunset next year

Taxes swing this decision more than most people realize. We’re in Q4 2025, and a bunch of TCJA-era rules are scheduled to sunset after December 31, 2025 unless Congress steps in. Plan with that in mind, but only count deductions you actually get on your 2025 return. Not theoretical, not what might happen in 2026, what lands on this year’s Schedule A.

First, the SALT cap. The $10,000 limit on state and local tax deductions was enacted in late 2017, effective 2018, and it’s still the law for 2025. Under current law, that cap sunsets after 2025. Translation: for this year, you’re still capped at $10k total across property taxes plus state income or sales tax. If you live in a high-tax state, that cap often eats the entire itemization benefit before mortgage interest even enters the chat. If Congress lets the cap expire, 2026 could look more like pre-2018 (bigger SALT deductions), but you can’t bank on that today.

Mortgage interest: the 2018 rules limit the deduction to interest on acquisition debt up to $750,000 for new loans after December 15, 2017 (older loans are generally grandfathered at $1 million). That $750k cap also sunsets after 2025 under current law, potentially reverting to the $1 million limit in 2026. Again, helpful if it happens, but it’s a 2026 story, not a 2025 deduction. If you don’t itemize this year, your mortgage interest is giving you no federal tax benefit; treat your mortgage rate as after-tax. Full stop.

Quick reality from what I’m seeing in client files this year: with mortgage rates around the high-6s to low-7s in Q4 2025 and headline inflation hovering near ~3% year over year, the “after-tax” adjustment only moves the needle if you actually clear the standard deduction and your incremental bracket is meaningful. If you’re barely over the standard deduction, only the dollars above that line get your marginal benefit. Example: you’re $3,000 over the standard deduction and pay $7,000 of mortgage interest, only $3,000 is effectively giving you your marginal tax rate benefit. People miss that all the time.

High earners: check your true marginal rate, not just the nominal bracket. The 3.8% Net Investment Income Tax (NIIT) still applies, and while TCJA suspended Pease itemized deduction phaseouts through 2025, state taxes and NIIT can push your effective marginal rate higher than you think. Don’t assume a 24% benefit if your last $1 is really taxed at, say, 18% after interactions, or 28% after NIIT and state. Math first, narrative later.

Near the itemization cusp? Bunch deductions. Timing charitable gifts and eligible medical expenses into one calendar year can push you solidly over the standard deduction, which then makes your mortgage interest actually count. I’ve done the donor-advised fund “bunch two years at once” move a couple times, works cleanly if cash flow allows.

One more wrinkle: capital gains and qualified dividends can make taxable investing more tax-efficient than it looks at first glance. Long-term gains and qualified dividends still use the preferential 0%/15%/20% brackets, and loss harvesting in down stretches can offset realized gains and up to $3,000 of ordinary income per year, with unlimited carryforward. If you harvested losses earlier this year on small-caps or EM (lots of folks did during that sloppy May-June stretch), your effective tax drag on the portfolio could be much lower than your headline bracket suggests.

• SALT: $10,000 cap still in place for 2025; scheduled to sunset after 2025 under current law.
• Mortgage interest: Deductible on acquisition debt up to $750,000 for post-2017 loans; limits could change after 2025.
• Standard deduction reality: If you don’t itemize, assume zero tax value from mortgage interest.
• High earners: Factor the 3.8% NIIT and state taxes when estimating marginal benefits.
• Bunching: Charitable and medical timing can push you into itemizing and increase the mortgage interest benefit.
• Taxable investing: Preferential long-term rates + loss harvesting can make the after-tax return better than it looks.

What I’d do at the keyboard: Run your 2025 itemization with real numbers (property tax already paid, state withholding estimates). If you’re not clearly over, assume your mortgage rate is your after-tax rate. Then compare that to your expected after-tax portfolio return, in real terms. If the spread isn’t at least 2-3% with a margin for error, I’d keep it simple and split the difference, or wait a quarter and recheck after year-end tax documents land.

Risk, liquidity, and sleep-at-night capital

Money isn’t math-only. It’s you, your job, your kids’ winter coats, and the card that’s going to get a workout between Halloween and New Year’s. Bonus season is a question mark this year, and that matters. Before you even think about extra principal payments, shore up your buffer. I tell clients (and I do this myself): keep 3-6 months of core expenses in cash. If your income is variable, sales, founder, bonus-heavy, lean closer to 9-12 months. Cash isn’t glamorous, but it’s the stuff that keeps small problems from becoming forced sales at the worst time. With inflation running near the low single-digits in recent years and savings yields still positive, the drag isn’t what it used to be in the zero-rate days.

Avoid concentration risk. Your house is a single, illiquid asset tied to your local economy. Every extra dollar you prepay increases concentration in that one asset while reducing your flexible capital. That’s fine if your total balance sheet is big and diversified. It’s not fine if most of your net worth lives in one zip code and a paycheck from one employer. I’ve seen this movie: job wobbles, roof leaks, markets dip… and the “equity” is paper-only because you can’t (quickly) turn it into groceries or tuition.

Sequence risk is real. Spreadsheet averages assume smooth sailing. Real markets lurch. Put $100,000 into a portfolio, catch a -20% drop early, and you’re at $80,000. You now need +25% just to get back to even. If you’re also withdrawing for holiday spend or an unexpected expense, that recovery takes longer. We all remember 2022’s broad equity and bond drawdowns, balanced portfolios fell at the same time, which shocked a lot of people who thought 60/40 couldn’t both be red. The point isn’t to scare you; it’s to respect timing risk when you compare “invest vs. prepay” on a clean spreadsheet.

Liquidity frictions are not theoretical. Refinancing or tapping a HELOC is not a same-day ATM. Typical HELOCs take 2-6 weeks from application to funding, and you may face appraisal fees and a rate spread over benchmarks. If market volatility spikes or your income gets uncertain, lenders tighten. That’s exactly when you want liquidity fast. Locking an extra $20k into your drywall is effectively a one-way valve. You can reverse it… but only slowly, and sometimes expensively.

And yes, I hear you: mortgage prepayments feel good because the return is certain. If your rate is 5%, the prepayment “earns” 5% before taxes with zero volatility. Investing has higher expected return, but it comes with variance and bad headlines at 6:30am. There’s also the inflation angle, if inflation averages around ~3% over time, your fixed mortgage cost gets easier in real dollars while your wages and rents around you drift up. That makes the case for keeping optionality: keep cash, invest a chunk, and avoid putting everything behind the sheetrock.

One more very human thing. If debt stresses you out, keeps you up at 2:17am, then a modest prepay cadence is worth the tiny expected-return tradeoff. I’ve told plenty of MDs on the Street to automate an extra principal amount that’s noticeable but not balance-sheet-breaking. Think $250-$1,000 a month depending on income. You get psychological relief, you still build liquid reserves, and you stop second-guessing every market wobble. Perfect? No. But workable. And durable.

My working checklist:
– Cash first: 3-6 months of expenses (9-12 if income is variable) in FDIC/NCUA-insured accounts (standard coverage is $250,000 per depositor, per bank, per ownership category).
– Diversification second: Don’t let home equity exceed what lets you sleep and still handle a 10-20% market squall without selling.
– Frictions matter: Assume 2-6 weeks to access new HELOC funds and that terms can tighten when you least want them to.
– Sequence-aware investing: If making a large lump-sum allocation, consider phasing it over 3-6 months, especially with year-end volatility and bonus uncertainty.
– Personal utility: If debt anxiety is high, set a steady (not heroic) prepay cadence and revisit after bonus and taxes settle in Q1.

And if you’re thinking, wait, we didn’t talk about the emergency tax bill that shows up in February… you’re right, I’m getting to that. But this time of year, keep your optionality high. Flexibility beats elegance when real life hits.

3% inflation lens: when fixed-rate mortgages quietly lose to time

Here’s the anchor I use right now: plan around 3% inflation. Not last year’s CPI print, not whatever headline is bouncing around this week, just a steady 3% planning assumption for the next few years. With that lens, a fixed mortgage’s real burden shrinks every year your paycheck and prices drift up. Payments are flat in dollars, but lighter in purchasing power. That nudges the math toward investing, unless your rate is high or your stomach for market swings is, uh, limited.

Quick rule of thumb I’ve used at the desk for years: real mortgage cost ≈ your fixed rate − your inflation assumption. If you hold 3% inflation as your base case, then:

• Sub-4% mortgages (say 2.75-3.99% from the 2020-2021 refi wave) look very hard to beat in real terms. Real cost is ~0-1%, before taxes. I wouldn’t rush to prepay those unless debt keeps you up at night.
• 5-6% mortgages are a coin flip. Real cost ~2-3%. If you expect a diversified portfolio to clear that hurdle after taxes and fees, investing makes sense; if not, partial prepay is defensible.
• 7%+ often tilts to prepay, especially if you’re not itemizing mortgage interest. Real cost ~4%+ is a tough bogey for conservative investors.

I’m simplifying a bit. Taxes matter. If you itemize, mortgage interest can be deductible on up to $750,000 of acquisition debt for mortgages originated after 2017 (TCJA rules). Many households don’t itemize because the standard deduction is high, which makes that interest effectively paid with after-tax dollars. Also, wages do tend to drift up over time, last year the Atlanta Fed Wage Growth Tracker averaged around 5% for job stayers in 2024, so the payment feels smaller as your income resets, even if your personal mileage varies.

A concrete picture helps: take a 30-year fixed at 6% with a ~$3,000 monthly payment on $500,000 borrowed. With 3% inflation, that same $3,000 is only about $2,230 in today’s dollars after 10 years (because 1.03^10 ≈ 1.34). That’s roughly a 25% lighter load in real terms. Your balance also amortizes faster than people expect in the back half of the schedule, which sneaks up, in a good way.

On the investing side, if you’re using a long-run yardstick, U.S. stocks have delivered roughly 6-7% real annual returns since 1926 (broad-market total return data; long horizon, lots of variance). Bonds are lower, obviously. The punchline: against a 3% inflation backdrop, a 3.25% mortgage is almost free money in real terms, 5.5% is debatable, 7.25% is a headwind you feel.

Not feeling great about equity valuations this year? Fine. Blend it. A practical approach I use with clients: set a partial prepay target (say 10-30% of surplus cash flow) and dollar-cost average the rest into a diversified mix. You reduce regret risk on both sides, if markets rally, you’re in; if they wobble, you paid down guaranteed debt.

If you want lower-volatility real returns next to equities, add an inflation-linked sleeve. TIPS give you a market-based real yield plus CPI; you can ladder maturities to match goals. I Bonds are tax-deferred, state-tax-free, and index to CPI; the annual electronic purchase limit is $10,000 per person, plus up to $5,000 more via a federal tax refund in paper form (TreasuryDirect rules, long-standing). I like using these as ballast when I’m not thrilled about taking more equity beta but still want real protection.

Two last caveats, because pretending certainty is silly: 3% inflation is a planning anchor, not a promise. If inflation settles at 2%, your real mortgage cost goes up a bit; if it runs hotter, it goes down. And your personal utility matters. If carrying debt makes you miserable, you won’t stick to the plan. In that case, make a steady, non-heroic prepayment cadence and keep investing something, future-you will thank present-you for the balance.

Make-it-real playbook: from paycheck to decision in two weeks

Here’s the two-week cadence I use with clients, and, yes, at our kitchen table during the year-end cleanup. The goal isn’t perfection; it’s clean reps and a clear decision.

1. Day 1-2: Lock in the basics
   • Emergency fund: Park 3-6 months of core expenses in FDIC/NCUA-insured savings or a money market. I tilt to 6 months if income is variable. No heroics here.
   • Capture your workplace match: Make sure your 401(k)/403(b) contributions end the year on pace to get the full employer match. Last year (2024), the employee deferral limit was $23,000 plus $7,500 catch-up at 50+. If your plan true-ups annually, front-loading is fine; if not, spread contributions so you don’t miss match dollars in late pay periods.
   • HSA funding (if eligible): For 2025, the IRS limits are $4,300 for self-only and $8,550 for family coverage, plus a $1,000 catch-up at 55+ (IRS notices in 2024). I treat HSAs like stealth retirement accounts, invest the balance after keeping one deductible in cash.
   • Kill high-interest debt: Anything with a double-digit APR is an emergency. Pay it first. I’ve never seen a clean plan that keeps 18% credit card balances alive.
2. Day 3-4: Compute your after-tax mortgage rate
   • First, confirm if you actually itemize in 2025. After the Tax Cuts and Jobs Act raised the standard deduction and capped SALT at $10,000, only about 10% of filers itemized in 2021 (IRS SOI data). If you don’t itemize, your mortgage interest isn’t lowering taxes, so your mortgage rate is effectively after-tax already.
   • If you do itemize, estimate the tax benefit % of mortgage interest. After-tax mortgage rate ≈ rate × (1, tax benefit). Watch the SALT cap and your charitable strategy; people overestimate this benefit all the time.
3. Day 5: Set expected return bands for your portfolio mix
   • Equities: I use a long-run band of ~6-7% real (about 9-10% nominal if you’re using a 3% inflation anchor). Historical U.S. large-cap real returns since 1926 are near 6.5-7% depending on the series you cite. Yes, ranges, not point guesses.
   • Quality bonds: Long-run real ~1-2% has been a decent planning range. If your current yield-to-maturity on high-grade bond funds is, say, 4-5% nominal, your real base case at 3% inflation is 1-2%.
   • Cash: Call it 0-1% real over time. It’s fine as dry powder, but don’t build a strategy on last quarter’s money market APY; those move with the Fed.

   Blend those based on your target allocation and horizon. My default is to keep the bands wide and my ego small.

4. Day 6: Make the decision rule explicit
   • If your after-tax mortgage rate is higher than your base-case expected portfolio return, prioritize prepaying.
   • If it’s lower by roughly 2-3 percentage points, prioritize investing.
   • If it’s close, go 50/50: automate a fixed monthly extra principal and auto-invest the same amount in your taxable or IRA brokerage sleeve.

   I know, rules of thumb feel blunt. That’s the point, speed beats perfection here.

5. Day 7-10: Automate the plumbing
   • Set up recurring transfers on payday: emergency fund top-up (if needed), 401(k)/403(b) deferrals, HSA contributions, and either the mortgage prepay or brokerage auto-invest (or both if you’re 50/50).
   • If you made a lump-sum prepayment, ask the servicer about a mortgage recast. A recast keeps your rate and term but re-amortizes to reduce the required payment. It’s often a small fee; timelines vary by servicer (I’ve seen 2-6 weeks), and not every loan type is eligible. Worth the phone call.
6. Day 11-14: Stress-test and sanity-check
   • Run a 1-2 standard deviation downside for equities in your head: if stocks drop 20-30% next year, will you still sleep? If not, you’re not 50/50, you’re more prepay-leaning.
   • Confirm liquidity after any prepay. I want at least three months of expenses untouched post-transfer. Non-negotiable, sorry.

Quick personal note: I did a 50/50 for six months when our rate felt “meh.” The tie-breaker was mental bandwidth, watching principal fall every month felt good, while still buying into the market. I think our recast fee was $150… or was it $200? I’m blanking, either way, small.

Where I get oddly enthusiastic: the January check-in. Revisit in early January when the 2026 tax picture starts to clarify. The TCJA individual provisions are scheduled to sunset after 2025, which could shrink the standard deduction and change who itemizes. If itemization rebounds, the after-tax mortgage rate math changes, especially with the SALT cap situation. Adjust the rule-of-thumb then, not now.

Final thought for this year: keep that 3% inflation anchor in your worksheet, but treat it as an anchor, not gospel. If inflation cools toward 2%, your real mortgage cost rises a touch; if it runs hotter, prepaying looks relatively better. Intellectual humility beats overconfidence every single time in this decision.

Tie it together: play offense with your balance sheet

The pros don’t hunt for perfect answers, they build systems that survive rate regimes, recessions, and the random Tuesday job surprise. With a 3% inflation anchor, the edge usually comes from boring discipline: allocate by rule, be honest about taxes, and keep cash ready so opportunity doesn’t go to voicemail. Offense, not bravado.

Start with real rates so you aren’t fooled by inflation. Nominal is the headline; real is the truth. The 10‑year TIPS yield hovered around ~2.1% in September 2025 (U.S. Treasury data), which is your market-implied real hurdle for long capital. If your after-tax mortgage rate is, say, 4.5% nominal and your inflation anchor is 3%, your approximate real mortgage cost is ~1.5%, but only if that 3% holds. BLS showed the 12‑month CPI running around the low‑3s in late summer 2025 (August was roughly ~3%-3.3%, depending on the index cut), which keeps the “real vs nominal” illusion very real right now. Point is: compare like-for-like. Real costs vs real returns.

Taxes are the swing vote, count only what you truly get. Today, the SALT deduction is still capped at $10,000, and the higher standard deduction is still in place through 2025. If you don’t itemize, the effective mortgage interest deduction may be zero. Don’t credit yourself with a deduction you aren’t actually taking. On the investment side, long-term capital gains max out at 20% federally (plus the 3.8% NIIT for higher-income investors), and dividends are usually qualified, but not always. State taxes can tilt the math another 0%-13% depending where you live. Quick mental math I use: estimate your after-tax expected return on the next dollar invested, then compare to your after-tax borrowing cost. If the spread is thin, don’t overcomplicate it.

When in doubt, blend payments and investments to reduce regret. If your head says invest but your gut says “I hate debt,” split the baby. Example: put 50% of surplus toward principal and 50% into a diversified, taxable portfolio or your next tax-advantaged bucket. This kept me sane during a 2018-2020 refi stretch and, if I’m remembering right, during our 2022 recast when the fee was like $150 or $200. The blended approach keeps compounding alive while de-risking the sleep-at-night factor. No heroics, no post-mortem self-loathing.

Protect liquidity so your plan survives bad markets and life hiccups. Cash is the permission slip to buy when others can’t. My baseline: 6-12 months of core expenses in true cash or T‑bills. In 2025, 3-6 month T‑bills have spent most of the year yielding north of 4%-5% nominal, call it roughly 1%-2% real versus the 10‑year TIPS bar. That’s decent carry for “dry powder.” If your liquidity falls under the floor, press pause on prepayments and top up cash first. You never want to sell your best assets into a down tape because the water heater exploded the same week your bonus got delayed. It happens, and it’s always the worst week.

Pay down when rates are clearly above your hurdle; invest when the spread favors you. If your after-tax mortgage is 5.5% and your realistic, after-tax, risk-adjusted expected return is 4%-5%, that’s a layup: pay down. Flip it around, if you can earn 6%-7% after tax with appropriate risk and your real mortgage cost sits near ~1%-2%, keep investing and maybe do smaller principal chips. I’m oversimplifying, yes. But this keeps decisions clean.

Success is boring: automate, rebalance, and review annually. Automate transfers to investments and to a standing “principal chip” if that’s part of your plan. Rebalance quarterly or semiannually, annually at minimum. Then do one deep review in early January. This year I’m telling clients the same thing I’m doing: keep the 3% inflation anchor for planning, but sanity-check it against the latest CPI prints and the TIPS curve. If the TCJA sunset actually lands after 2025 and itemization comes back for more households, re-run the after-tax mortgage rate in January with your actual Schedule A reality.

Play offense by system: use real rates, count only the tax breaks you truly get, blend when you’re unsure, defend liquidity, and let automation carry most of the load. It isn’t flashy, but that’s exactly how wealth compounds.

Frequently Asked Questions

Q: How do I figure out if paying extra on my 6.75% mortgage beats investing when inflation is ~3%?

A: Start with a back-of-the-envelope hurdle rate. With CPI running ~3% this year, your 6.75% fixed feels like ~3.75% in real terms before taxes. If you itemize and can deduct interest, your after-tax real cost may be closer to ~3%-3.3% depending on your bracket. Now ask: can you realistically earn a higher risk-adjusted, after-tax, after-inflation return elsewhere? If yes, invest. If no, prepay. But hit emergency savings, high-APR debt, and employer match first.

Q: What’s the difference between nominal, real, and after-tax mortgage rates, and why should I care?

A: – Nominal rate: the sticker on your loan. If it’s 6.75%, that’s what your lender charges before taxes and before considering inflation.

• Real rate: nominal minus expected inflation. With ~3% CPI this year, the real cost feels ~3.75%. Fixed payments get cheaper in purchasing-power terms over time.
• After-tax rate: what you effectively pay after the tax code. If you itemize and your marginal tax rate is, say, 24% federal (state varies), your after-tax nominal cost could be 6.75% × (1 − 0.24) ≈ 5.13%. Convert that to real by subtracting expected inflation (~3%), giving ~2.1% real. Why it matters: Decisions live at the margin. You shouldn’t compare a 6.75% nominal mortgage to a 6.75% expected stock return. You should compare your after-tax, real mortgage cost to the after-tax, real, risk-adjusted return of your alternative. And yes, risk-adjusted is doing a lot of work here: equities may pencil at 5-6% real over long horizons, but with drawdowns that can force bad behavior. If your time horizon is short or you hate volatility, the required return to justify investing should be higher. I’ve personally over-prepaid when markets were cheap, looked conservative, but it was actually a misallocation given my horizon. Get your definitions right, then pick the cleaner tradeoff.

Q: Is it better to max my 401(k) or prepay my mortgage right now?

A: Usually 401(k) first, especially the employer match, it’s a 50-100% instant return and I don’t know many mortgages yielding that. After the match, prioritize HSA (if eligible), then keep stuffing the 401(k)/IRA up to annual limits. Only then compare mortgage prepay vs. taxable investing. With 30-year rates sitting mid-6 to low-7 this fall and CPI near ~3%, your real, after-tax mortgage cost may be ~2-3%. Many investors can beat that in diversified portfolios over time, but only if they actually stay invested. If you’re debt-averse or retiring soon, prepaying more can be the right sleep-at-night move.

Q: Should I worry about losing the mortgage interest deduction if I switch from itemizing to the standard deduction?

A: Yes, because the deduction’s value drops to zero if you don’t itemize. With the standard deduction still large and SALT capped, many households don’t clear the itemizing hurdle. In that case, your after-tax mortgage cost is effectively the nominal rate. If you’re close, consider bunching deductions (charity, medical timing) in alternating years. I know, annoying, but it’s real money. Keep receipts, future you will thank you.

@article{pay-off-mortgage-or-invest-with-3-inflation-do-the-math,
    title   = {Pay Off Mortgage or Invest with 3% Inflation? Do the Math},
    author  = {Beeri Sparks},
    year    = {2025},
    journal = {Bankpointe},
    url     = {https://bankpointe.com/articles/payoff-or-invest-3-inflation/}
}