In a case where you have the financial capacity to pay off your mortgage early but opt to keep your funds, you are effectively investing in real estate with money that you borrowed. This is a wise move if you see that after factoring in the risk and tax implications, your expected rate of return from your investment will exceed the cost of the mortgage. But many people don’t look at it that way.
Paying Off Your Mortgage Early
Your financial situation might have had an upturn recently: a hefty pay raise at work, an inheritance from a rich uncle or a raffle winning that makes you feel like you can put the extra income to repay your mortgage faster and not wait for many years. If you really have a ton of cash, you could put it all down as one large mortgage repayment or spread it out to add to what you normally pay every month.
Whatever it is, you can get huge savings and would likely cut months and perhaps years off your total mortgage repayment period.
But before you do go on, check the terms of your mortgage contract to make sure that the lender doesn’t impose a penalty on you for repaying your mortgage ahead of schedule. When considering to retire a mortgage early, the homeowner should analyze his feelings about borrowing, the opportunities available to make more income if he invests the money elsewhere, any potential tax savings with mortgage interest, his future plans and the total debt burden.
Benefits Of Paying Off Your Mortgage Early
There are a couple of great reasons to pay off your mortgage early, here are the major pros:
Save on Interest
The most compelling motive to pay off a mortgage early is to avoid paying more interest on the loan. If you do your math and compute the total interest that you will pay on your mortgage if you let it run its full term, the amount can be overwhelming.
Look at the table below and check out the impact of interest on a $250,000 mortgage for 30 years with a fixed rate of 4.75%, 4.5% and 4.25%:
|Annual Percentage Rate||4.871%||4.703%||4.533%|
|After 10 Years||$156,494||$152,005||$147, 580|
|After 30 Years||$469,481||$456,018||$442,7456|
When you make additional payments to your mortgage early, you don’t just reduce your total outstanding debt. You also lessen the interest cost that you will owe on the remaining balance. That would create a snowball effect that will enable you to pay down your mortgage faster than the time you thought it would take.
Downsizing Near Retirement
It’s usual for older homeowners to downsize their living quarters because, without their kids, their houses have become too big for their needs and it becomes harder to navigate or clean. Downsizing before you retire is a good move because as a seller, you tend to make a huge profit from the sale.
You can use part of the money to buy a smaller property and use the rest for your retirement savings. Remember that towards the end of the mortgage term, you would have naturally built up more equity in the home so when you sell it, you receive more profit.
If you still owe a balance on the home (perhaps a few thousand dollars more), you must still pay the lender before coming out with the pure profit. When you pay off the home, you’d have more funds for a new residence and still have extra for retirement.
Peace of Mind
There’s no substitute for the feeling of security that comes in knowing that your home is already yours because you’ve paid for it in full. If you share the same sentiment, it may be to your advantage to pay off or reduce the amount of your outstanding mortgage.
When you borrow, you are essentially relying on your future ability to pay back the money you can get at the present time. Many people are comfortable taking the risk but you should always consider all the factors and not just the interest rate alone.
If your life circumstances take a downturn such that you become incapable of paying your mortgage, where would you go? If something like that happens when you have already paid off your mortgage, at least, you’ll have peace of mind because you’re free from one of the most burdensome debts you once owed.
Why You Should Not Pay Off Your Mortgage Early
Some financial advisers would actually recommend NOT paying off your mortgage early. Here are their reasons:
The biggest disadvantage to paying off a mortgage early is that it reduces your liquidity.
Any amount you channel to pay off your mortgage ahead of time means you sacrifice the same amount that you could use for something else such as for savings, investment or an emergency fund.
If you gave up setting an emergency fund because you prioritized an early mortgage payoff, a sudden financial disaster could force you to borrow money at a more costly rate and term. And if you weren’t able to pay your mortgage in full, an emergency could prevent you from making timely payments that could lead to foreclosure and eventually, loss of your home.
Of course, you can avail of the equity you’ve built up to get a refinancing or a line of credit, but these loans take time to apply for and may sometimes cost higher – plus, there’s no guarantee that you can get it immediately.
Your Money Can’t Grow
If you pick paying off your mortgage now, you essentially give up your chance to invest the money.
Putting all your extra cash in your mortgage means letting go of the opportunities to earn higher returns and giving up the compound growth that an investment in the stock market, real estate or your own business can provide.
Lose Tax Break
Even if you pay mortgage interest every month, you can still avail of its benefit as a tax deduction. In the early years of a mortgage are when the interest payments are at their highest so many homeowners take advantage of their sizeable deduction.
This gives you great benefit if you are in a higher tax bracket. If you’re just paying a little interest on your mortgage, any tax savings you can get might be insignificant.
Here’s another point to consider: if you use your money to pay your mortgage, you forego of the money that you could invest in a 401(k) or IRA. At the same time, you also forfeit the allowable yearly tax break on retirement savings. You don’t even have to claim itemized deductions to avail of these tax breaks because they would work as well even if you’re using the standard deduction.
Should You Pay Off Your Mortgage Early?
Here are a few questions to help you decide the better option for you:
1. Do I Have Any Other Debt?
Onerous debts are the ones that will cost you a lot of money to pay off over time. Credit cards and store cards are notorious for their high-interest rates for just a year. Other examples might be unsecured loans that have interest rates that are higher than your mortgage rate.
2. Do I Have Enough Reserve?
Make sure that you’ve set aside enough savings to keep your present standard of living for at least three months before you pay off your mortgage early.
3. Is There Are Savings Rate I Can Get That’s Higher Than my Mortgage Interest Tate?
If you’re already making contributions to a pension scheme, it might be a better option to put your money into a savings account rather than retiring your mortgage. That’s dependent on whether you can find a savings account that pays a higher interest rate than what you’re paying on your mortgage.
4. Do I Contribute To Pension?
Pensions are tax-efficient because the government “adds” to your contribution through tax relief. If you’re also fortunate enough to have a company plan, your employer might match your contribution.
If you did not enroll in a pension plan but have some extra money, why don’t you consider joining one? The earlier you come in, the faster your retirement pot will start to grow.
Financial planning is unique for each person, there is no single uniform process that fits everyone. Your spending habits, timelines, risk-tolerance, loss tolerance as well as your personal financial goals are necessary inputs to determine an effective strategy.
In the end, your final decision might depend more on your personal psychological makeup rather than finances or your specific financial situation. For others, the security of owning their own homes outweighs the concern of letting potential market gains pass. And to some, having a mortgage debt is fine as long as they have more liquidity and can be responsive to investment opportunities.