Paying off your mortgage early sounds like a great idea. Getting rid of a monthly house payment frees up cash and leaves you with one less expense to worry about.
But should you pay off your home ahead of schedule? Your financial circumstances and goals will dictate the answer, says Clarissa R. Hobson, certified financial planner with Transform Wealth in Greenwood Village, Colorado.
“It definitely depends on the current mortgage interest rate you’re paying, how you plan to invest the funds and how important the mortgage interest deduction is to your tax situation,” Hobson says.
Read on to learn more about the pros and cons of paying off your mortgage early.
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What Are Pros and Cons of Paying Off Your Mortgage Early?
— You eliminate what is likely your biggest monthly expense.
— You can save thousands of dollars in interest over the life of your loan.
— You free up money in the long run for other goals, such as saving for retirement and traveling more often.
— You will have less cash for expenses in the short run as you devote so many dollars of your savings and earnings to paying down the mortgage.
— You may save less in interest than you could gain by investing the money elsewhere.
— Your lender could charge a prepayment penalty for early payoff.
Should You Pay Off Your Mortgage Early or Invest?
Your life circumstances and goals will help you determine whether paying off your mortgage early or investing the money is the right path forward.
In some situations, putting extra money toward the mortgage works. “If you’re currently paying a relatively high interest rate on your mortgage and believe you are unlikely to make a higher return on your investments, an early payoff could make sense,” Hobson says.
Homeowners who prize certainty may also prefer paying off the mortgage instead of investing. That is because the return on a portfolio is not guaranteed and subject to volatility, says James Lee, a New York-based certified financial planner and president-elect of the Financial Planning Association.
“On the other hand, paying off a mortgage provides a guaranteed return on the money equal to the interest rate on the loan,” Lee says.
In other cases, paying down a mortgage faster might be a mistake. “It may make financial sense to invest the funds rather than pay off the mortgage,” Lee says, if you put them in a well-diversified portfolio with a target rate of return that exceeds your mortgage interest rate savings.
If your mortgage interest rate is very low or you benefit from the mortgage interest tax deduction, you also might not want to accelerate your payoff, Hobson says. “If having that deduction keeps you in the 12% tax bracket and means you’re paying a 0% rate on capital gains, keeping the mortgage in place may make sense,” she says.
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Questions to Ask Yourself Before Paying Off Your Mortgage Early
1. Are your finances in good shape? Have you paid off higher-rate debt, such as credit cards, and saved an emergency fund?
2. What will you gain from paying off your house early?
3. Does your mortgage have a prepayment penalty for early payoff?
4. Will paying off your mortgage leave you with enough liquidity to cover other expenses?
5. Could you get a better return on your money by investing it?
6. Will you lose a key tax deduction when you pay off your mortgage?
7. Do you have enough money to pay down your mortgage and save for retirement?
8. How will life change when you pay off your mortgage? What are the emotional benefits?
Should You Refinance Instead of Paying Off Your Mortgage Early?
In some cases, refinancing could make more sense than paying off your mortgage.
A refinance can help you maintain liquidity and give you money to invest, Hobson says. “It will likely also allow for a lower monthly payment amount or shorter repayment term, depending on the parameters of the new mortgage,” she says.
But you will need to weigh these advantages against disadvantages such as the upfront fees and closing costs of refinancing, Hobson says. A refinance can also be time-consuming and may lengthen your repayment period, which could be costly in the long run, she says.
“If you intend to sell your home in the near future, you may not break even on the refinance,” Hobson adds.
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Ways to Pay Off Your Mortgage Early
If you’re ready to pay off your mortgage, you can take steps to make the process easier, including:
— Paying biweekly.
— Budgeting for an extra payment each year.
— Refinancing to a shorter loan term and making bigger monthly payments.
— Switching to an adjustable-rate mortgage with a lower interest rate and applying the savings to your principal.
You may also want to use cash on hand or money in a taxable investment account to make bigger mortgage payments, Lee says.
He adds this caveat: “Money withdrawn from traditional IRAs or employer-sponsored retirement plans, like 401(k)s, is taxable as income and could be subject to an early withdrawal penalty if you’re under 59 1/2.”