For most of us, our home is our most valuable asset. It is also our most significant liability and the biggest loan we will ever have to repay. Therefore, it makes sense to want to settle out your mortgage as quickly as possible.
There are several reasons why this may be the right decision for you. First, it can reduce the amount of interest you pay over the life of the loan. Second, it can provide peace of mind by eliminating a significant monthly expense. Third, it can free up cash flow available for other purposes.
With so many factors involved, whether or not to pay off your mortgage can be a difficult decision. This post will provide all the details you need to make your decision easier, including the primary considerations, benefits, and disadvantages of paying off your mortgage early. Let's jump right in!
The Advantages of Paying Off Your Mortgage Early
1. Interest Savings
This is the number one reason most people would consider paying off their mortgage early. Even in today's low-interest-rate environment, interest can add thousands of dollars to your loan over the term of your mortgage. Paying off your mortgage early will save you money in interest. The sooner you pay off your mortgage, the less interest you will pay on the borrowed principal.
2. Build Equity and Net Worth Faster
Paying off your mortgage early will also help you build equity in your home more quickly. Equity is the portion of your home that you own outright; it's the difference between your home's value and the amount you still owe on your mortgage. For most people, the equity in our home accounts for the largest share of our overall net worth.
3. Peace of Mind
For some people, paying off their mortgage as quickly as possible gives them a sense of security and peace of mind. If you worry about making your monthly payments or want to be debt-free as soon as possible, paying off your mortgage early may be the best decision.
4. No Monthly Mortgage Payments
Once you pay off your mortgage, you will no longer have a monthly mortgage payment. Eliminating monthly mortgage payments can free up money in your budget for other expenses or goals. You may also want to reduce your fixed monthly expenses to prioritize travel or invest in a healthcare plan if you are nearing retirement.
The Disadvantages of Paying Off Your Mortgage Early
1. Tying up Funds in Your Home's Equity
While paying off your mortgage early means that you own your home outright, it also means that you are tying up funds in your home's equity. If paying off your mortgage early limits your access to cash, it can be detrimental when you need to access that money for investments, travel, or unexpected expenses.
2. Opportunity Cost
Paying off your mortgage early also means missing out on other opportunities, such as investing in a new business idea or a diversified portfolio, which could offer greater potential returns. Mortgage rates are currently at all-time lows, so if you can get a higher return elsewhere, you can get more value from the money you would have used to pay off the mortgage.
3. Paying a Penalty
Some mortgages come with a prepayment penalty. In some cases, the penalty can cancel out any possible interest savings. Be sure to check the terms of your mortgage before making any decisions.
4. Lose Your Tax Shield
If you itemize your taxes, you may be able to deduct the interest you pay on your mortgage. Paying off your mortgage early means you will lose out on this deduction. As per Bankrate, you can deduct the mortgage interest paid on the first $1M of your mortgage if you bought your home after December 16, 2017. After that date, if you purchased your home, the limit is up to the first $750K.
Factors To Consider Before You Pay Off Your Mortgage Early
1. Mortgage Terms and Conditions
You should read your mortgage terms carefully and check with your lender to ensure that you are permitted to prepay your loan. Are you allowed to prepay by your lender? Is there a prepayment penalty clause?
2. Other Debts
Paying off your mortgage early may not be the best decision if you have other debts with higher interest rates, such as credit card debt or student loans. For example, your mortgage interest rate is 3%, and you have an outstanding credit card balance that charges 20% or more in interest. In this scenario, you would want first to target paying off your credit card balance in full.
3. Financial Goals
You should also consider your overall financial situation before paying off your mortgage early. If you have other financial goals, such as saving for retirement, you may want to prioritize those over paying off your mortgage.
4. Investment Plan
How will you invest the money you save by not paying off your mortgage? Will other investments yield a better return than the benefit you get from early paying the mortgage? You should have a plan for what you will do with the funds if you don't prepay your mortgage. If funds are going to remain in your account, prepay your mortgage. If you invest, the funds are being put to good use.
5. Emergency Fund
Do you have an emergency fund set aside, or will you use all your cash to prepay the mortgage? Not having any funds set aside for emergencies could leave you vulnerable if something comes up. Paying off your mortgage early may leave you without the cash you need for an emergency expense, so plan to set aside 3 to 6 months of expenses before spending your cash.
Different Options To Pay Off Your Mortgage Early
1. Pay the Entire Mortgage
Lump-sum mortgage amount + prepayment penalty (if any) from your savings. If you have been saving up for a while and have a lump sum of money, you can use that to pay off your mortgage early.
2. Refinance the Mortgage
You can refinance your mortgage to a shorter term, which will help you pay off your mortgage early. This will lead to higher monthly payments, so make sure your monthly budget permits it.
3. Annual Top-up
Most lenders allow you to pay a percentage of your original mortgage amount as a lump sum payment each year without any penalty.
4. Change Payment Frequency
You can accelerate the principal repayment and lower your overall mortgage interest cost by changing your monthly payments to bi-weekly or weekly.
So Should You Pay Off Your Mortgage Early?
Considering all the factors and trade-offs based on the state of the economy in 2022, we don't believe it is worth paying off your mortgage early. Interest rates are at record lows, even with recent increases, and there are better options to invest your money.
Paying down your mortgage will save you interest costs, but it doesn't offer the potential for higher returns than you could earn by investing your money elsewhere. If you have a comfortable emergency fund and good job security, look for opportunities to leverage your cash elsewhere.
At the same time, inflation and interest rates are increasing in 2022. Stock markets are experiencing a high level of volatility as well. For those that don't have the time or the risk appetite to weather the storm, changing market conditions may warrant a rethink of financial plans.
For example, if you're close to retirement or anxious about market swings affecting your investments, paying off your mortgage may be a wise move. If you have cash sitting in your savings account, it loses value due to inflation. If you do not intend to invest, use your money to pay down your mortgage instead and use the rising value of your house as a hedge against inflation.
Ultimately, the best way to decide is to assess your financial situation with the help of all the tips above and develop a plan that's right for you and your family.
Ash & Pri are the Founders of AshandPri.com where they empower others to make smart money decisions across all aspects of life. They achieved financial freedom in their 30's and have traveled to over 30 countries, thanks to a disciplined approach to money management. Both hold an MBA degree and have 13+ years of experience in financial services, consulting, and telecommunications.