Like many homeowners, you may be wondering whether you should make additional mortgage payments or put any extra cash you have toward paying off your home early. The answer is probably not what you expect.... Unfortunately there is no clear cut answer because it depends on your financial situation. Read on to find out if it’s worth it to pay off your home early or if your money can be better used elsewhere.
Advantages of Paying Off Your Mortgage Early
Additional Cash Flow Later On
By allocating more of your money now to paying off your mortgage, you will have additional cash flow later on when you have less debt. This means that in retirement or before then you’ll have more money to save or invest. With less monthly expenses you may feel a weight lifted off your shoulders. Depending on your stage in life, it may make sense to have peace of mind knowing you own your home and have one less monthly payment.
Save On Interest
Paying off the principal of your mortgage early will enable you to save on interest compared to if you make the minimum payments for the entire term of the loan. This can be a significant amount depending on your interest rate. For example, if you buy a $250,000 home with a 30-year mortgage, 20% down payment and a 4.5% interest rate, you will pay about $165,000 of interest over the term of your loan. That’s basically paying for another house. Considering your principal was only $200,000 at the start of the loan, you would be paying 82.5% of another $200,000 home. This idea of saving so much money in interest is a main reason why paying off your mortgage early is so attractive to many people.
Use Home Equity
By paying off your mortgage early, you can sell your home and receive the entire amount rather than having to pay off the remainder of your mortgage. If you plan to stay in your home, you can take out a home equity loan or home equity line of credit with your equity in the house as collateral.
Own Your Home
Putting all of the financial aspects of this aside, an advantage of paying off your home early that we can’t ignore is the appeal of owning your home outright. When you buy your home with a mortgage, you are considered a “homeowner” but really you are still borrowing from the lender. Once you pay the lender back, then real “homeownership” begins.
Disadvantages of Paying Off Your Mortgage Early
Higher Return On Other Investments
Rather than paying off your mortgage early, you could use that extra cash to invest. That investment may provide a higher return than paying off your home. This trade off is especially important if you are younger and more likely to make riskier investments with a higher return than if you are retirement age and making conservative investments. This again depends on your stage in life and investing mindset.
If you have a long-term fixed rate mortgage, then the lender assumes the risk of inflation. This means that as the inflation rate rises over time the cost of living increases, but your interest rate stays the same. Consequently, the payments to the lender are less valuable over time.
Moreover, while you are still paying off your mortgage the lender also assumes the risk that the real estate market will fall and the value of the property will drop. When you pay off your mortgage, this risk is assumed entirely by you.
Lose The Mortgage Interest Deduction
While you’re paying your mortgage, your taxable income can be reduced with the mortgage interest deduction. This deduction no longer applies when you pay off your mortgage. Extra payments toward the principal of your mortgage are also not deductible.
Your home is an illiquid asset, this means it cannot be sold easily as it takes time to sell a home. By paying off your home early, you are reducing your liquid assets, cash, and turning them into an illiquid asset.
To reduce the risk of needing cash and going into debt later, you should save while you’re paying off the home so that you have an emergency fund that can cover several months of expenses.
Consider Your Situation
Now that you know many of the pros and cons of paying off your mortgage early, you can make an informed decision. Think about the stage of life you’re in, other investment opportunities and the risks that the lender currently assumes. This is not a decision to be taken lightly so take your time deciding and consider all of the factors.
If the amount of interest you will pay over the term of your mortgage is a major concern for you, you should consider refinancing your mortgage loan. Refinancing can get you a lower interest rate and better terms on your loan.
Learn more about the ins and outs of your mortgage by reading Understanding Your Mortgage - What’s Behind The Scenes.
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