Some homeowners may be uncomfortable with the idea of being indebted to a lender for several decades and may want to pay their mortgage off early. But should they?
If you are considering this, the first thing you need to do is reach out to your lender to see if you can. Your mortgage may have a provision that would require you to pay a penalty if you pay the loan off early. If you can pay it off early, there are many factors to consider when deciding if you should.
Your Unique Situation
Your personal situation (your finances, your age, your plans, etc…) is paramount when deciding whether or not to pay off your mortgage early. One important factor is your spending habits. If you think you may blow your extra cash and spend it on unimportant things, it might be smart to pay your mortgage off early. But if you’re smart with your money and a good saver, it might not be the better choice. Think about how you would otherwise use that money and what you would put it toward if not paying off your mortgage. Also, consider your long-term financial goals. Are you planning for retirement? Are you saving up for a child’s college tuition?
Or maybe you’re someone who values peace of mind and would get stress relief from owning your home free and clear. Not everything is about money. Paying off a loan can give people a sense of freedom and lightness, especially going into retirement. If you are someone who would benefit mentally and emotionally from not having to pay a lender every month, then paying your loan off early could be right for you. There are many things to consider that are unique to your situation.
Paying off your mortgage early could cost most or all of your cash flow and liquidity, which refers to how quickly an asset can be turned into cash. So be mindful of your liquidity and the cash you have on hand to ensure that you are able to pay your bills, cover your living expenses and maintain an emergency fund for anything that could arise in the future, such as job loss and medical bills. A house is not a liquid asset, because it takes a long time to convert into cash.
If you have investments, you may find that keeping your mortgage intact and investing is a better use of your money. With mortgage rates at record lows, the return of paying your mortgage off early would likely not be as great as that of investments. There is risk in the stock market, of course, but there’s also risk in paying your loan off early. For one, if real estate prices drop after you’ve already paid it off, you could take a loss.
Generally speaking, financial experts recommend paying off high-interest debts before paying off other debts. If your other debts (such as school loans, credit card debt, and car loans) have higher interest than your mortgage loan, it would be advisable to pay those off first. Plus, interest on your mortgage is tax-deductible, while the other loans are not.
If you’d like to pay off your mortgage sooner, one option to weigh is a refinance. In addition to possibly getting a better interest rate, you can also shorten your mortgage from a 30 year loan to a 15-year loan. Your monthly payments will be higher, but you’ll pay off the loan sooner and will save on total interest.
After considering your personal situation and the factors referenced above, there are some objective benefits and drawbacks to paying off your mortgage early.
Saving money on interest. When you make a mortgage payment every month, you’re not just paying back the loan itself, you’re also paying interest. The sooner you pay off the loan, the less total interest you’ll pay.
No more monthly payments. Not having to make a mortgage payment every month frees up money to spend on other other things, which could be especially helpful to senior citizens and others on a fixed income.
The ability to take out a reverse mortgage, home equity loan or home equity line of credit (HELOC). By owning your home outright, you have the equity to take out a loan against the house should you need it. With a reverse mortgage, the lender pays you, and the loan is paid back years later via the ultimate sale of the house. With a home equity loan, the lender gives you a lump-sum which you pay off in regular monthly installments until the loan is paid. A HELOC is like a credit card and allows you to withdraw up to a certain credit limit.
Diminished liquidity and cash flow. As mentioned previously, paying off your mortgage early could use up a lot of your cash and liquidity.
No tax deduction. While paying off your mortgage, you are eligible for the federal mortgage interest tax deduction. Once that loan is paid off, the tax deduction no longer applies.
Missing out on investments. Also mentioned earlier, paying off your mortgage early will likely not get you as great of a return as that of investments, so investing may be a better use of your money.
Lower credit score. Having a loan and/or a line of credit actually builds your credit. If you take away one line of credit, your credit score will go down. This is a more minor drawback, but it’s something you should be aware of nonetheless.
The Bottom Line
Be sure to weigh all the factors before deciding to pay off your mortgage early. While it could save you money in the long term, it could also be detrimental in the short term. You may save money on total interest, but you may also lose money on missed investments and tax deductions and cut into your cash flow. As my mother used to tell me, “The right thing to do is the thing you do,” meaning that whatever decision you make will be the right decision. Educate yourself and talk to your financial advisor, and you will make the right decision for you and your family.