When You Get a Windfall, Should You Buy a CD or Pay Off Your Mortgage?

Everyone has a secret fantasy that they'll open their mailbox and a mysterious check will be inside waiting for them. This check, of course, is legit, and it's significant. This is way better than winning the lottery somehow, because it's your check, written to you, and no one else has to know you have it.

Well, sometimes that happens -- it's called a windfall, and it might be an inheritance from a distant family member, a surprise buy-out of a company you own shares in, or something else wholly unexpected. It can be tempting to spend that found money right away, but if you let it simmer, there are probably better options.

For many people, the choice comes down to two: invest it or pay off your mortgage.

If it's a smaller amount of money, perhaps less than $10,000, it's very tempting to just send it flying into a mid-life crisis. But for bigger dollar amounts, let's say $100,000, it's a more serious venture. If you're at an age where you're getting inheritances and having mid-life crises, it's likely you've already gotten a lot of the big financial milestones knocked out. You probably own a decent car, you're paying on a mortgage, maybe the kids are already through college.

Paying off your home with found money

Some people choose to pay off their homes with significant windfalls, and it's not that it's wrong to do so, but there are many scenarios in which that isn't always your best move financially.

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Paying off your home comes with intangible benefits like peace of mind, and simply not having to budget for the mortgage every month, even if you do still have to pay taxes and insurance. Those are benefits that can't ever be argued to be worthless, but they certainly aren't money makers, either.

Buying a certificate of deposit with found money

Right now, short-term certificates of deposit (CDs) are returning pretty well, especially considering the relatively low commitment required. Western Alliance Bank, for example, offers a 12-month CD through the Raisin platform with a 5.05% APY, a $1 minimum investment, and no additional fees.

So, if you were to take your $100,000 check and leave it with the bank for a year, at the end, you'd have $5,053.20 more than you had before. Which is pretty awesome for doing literally nothing, no lies. The best part is being able to take that $105,000 and turning it around to do it all over again.

Buying a CD vs. paying off the house

Let's look at the two scenarios side by side. Assuming your interest rate on your home is 4.00%, on the surface, your money is making more money in the CD. But what about the particulars?

Assuming you bought your house in 2012 for $154,000 and you put down $15,400 (10%), your 30 year fixed-rate mortgage was for $140,000 at 4.00%, and when you get your windfall at the end of 2024, you still owe $100,493.63 on your note. About $39,000 of that is principal and about $61,000 is interest -- and you've got 18 more years left to pay. The lifetime interest you'll pay for all 30 years is $100,617.31

So, if you pay off the mortgage note today, you'll save $39,198.08 in interest, and you'll no longer have a house payment -- pretty sweet deal.

But wait, there's more.

If you put that money into a certificate of deposit, reinvest the interest, and are able to continue to see a 5% return yearly for the remaining 18 years of your mortgage, the magic of compounding will return $140,661.92 to you in interest alone. You'll have to pay taxes on these gains based on your total income, and interest rates are never guaranteed into the future. We can only work with what we've got.

Here's a chart to illustrate how that works.

So, here we have two choices: pay off your home today, and save about $40,000 in interest over the next 18 years, or invest the newfound windfall into a CD with a 5.00% APY, and earn $140,000 in interest over the same time frame, assuming nothing funny happens with interest rates.

Of course, there are plenty of reasons to pay your mortgage off now, but with such a low interest rate note, it really is kind of like cheating yourself out of $140,000 later if you can invest the money and simply let the mortgage note live out its natural life.

For your money, investing the windfall could be the right answer, but money isn't everything.