Should you pay off your mortgage early? The answer is different for everyone and depends on your unique financial circumstances. This blog lists some of the reasons that an early payoff might benefit you, followed by a few reasons it could make sense to stick to the original payment plan.
The Case for Early Payoff
It could make sense to pay off your loan early if you want to free up income to put towards a new mortgage. If you plan to purchase a second home or investment property, but your debt-to-income ratio is too high to qualify for an additional payment, you may want to pay off your existing mortgage, and then apply for the new loan.
If your interest rate is high and refinancing would not result in a lower rate or payment, you may want to make additional payments toward the principal each month to reduce your overall interest burden. Over the life of the loan, this can make a big difference, especially if you start chipping away at the principal early.
When Waiting Makes Sense
If your mortgage has a prepayment penalty, discuss the cost of early payoff. You may want to wait until after the penalty expires to pay off your loan. Prepayment penalties are set to expire at a predetermined date, such as three years after the first payment was due.
If you do not have an emergency fund of at least six months of living expenses, build that up first, and then consider paying down your mortgage.
If you have debts with higher interest rates than your mortgage, such as a credit card or student loans, it might make financial sense to pay off those debts before paying off the lower-interest home loan.
If your mortgage is the only payment being reported to the credit agencies, you may want to keep the account open until you have an additional account, such as a credit card that you pay off monthly. The credit reporting agencies that determine your FICO® score need information that they can rate. For more on how a mortgage payment could affect your credit score, check out this blog.
Most municipalities offer a tax benefit in the form of a mortgage exemption. Find out if and by how much your taxes would increase if you paid off your mortgage.
How To Pay Off Your Mortgage Early
If you have decided to pay off your mortgage early, the following plans may help you plan for the future.
Lump Sum Payoff – Some homeowners choose to pay off their mortgage in one lump sum. Call your mortgage servicer for an exact payoff amount before sending payment. Also, inquire about any prepayment penalties to determine whether now is the right time for a payoff. You might have to part with a large piece of capital, but you will no longer be paying interest on your home.
One Extra Payment – It is common practice for some borrowers to budget for one extra mortgage payment per year. This scenario involves saving 1/12 of the mortgage amount each month, then sending the extra payment as an additional principal payment at the end of the year.
Biweekly Payments – Some mortgage servicers offer the option of biweekly billing. This is a method that helps homeowners pay down the principal early, one month at a time. The mortgage amount is split, and the first half is billed earlier in the month. This equates to twenty-six payments each year, so in essence, you are making 13 payments each year instead of the required twelve.
Extra Monthly Principal – If you have extra cash in your budget, it might make sense to pay a predetermined amount of extra principal with each of your regular monthly payments. This approach can benefit a household’s net worth when the mortgage interest rate is higher than the interest that would be earned on investments.
Yearly Principal Buydown – This is the method that some homeowners use when their tax refund arrives. Applying a one-time payment toward the principal can significantly reduce the amount of interest you pay over the life of the loan, especially if you start on year one of your mortgage.
Before paying off your loan, discuss your plan with your tax preparer and loan originator. You should also discuss advantages and disadvantages with your financial planner, if you have one. Paying off your mortgage early may or may not be the best option for your household. Either way, the experienced team at Ruoff Mortgage is always here to answer questions and help with your home financing needs!