When you purchase a home, the prospect of a mortgage hanging over your head for decades can be intimidating, so it’s reasonable to just want to pay off your mortgage as quickly as possible.
Before you choose to sacrifice an inheritance, a bonus, or personal savings to pay off your mortgage (or even make extra payments), you should consider if it makes economic sense for you to do so.
In some circumstances, the sum you save on interest by paying off your mortgage early may not be greater than the amount you would make if you put the money to work elsewhere.
On the other hand, it is sometimes more about peace of mind or freeing up cash flow than it is about the return on other investments.
Yes, it’s entirely possible in the US to pay off your mortgage in full. If you’re thinking about paying off your mortgage early, and in full, you should consider contacting your mortgage lender or provider first.
You may discover, depending on the conditions of your loan, that you are liable to a prepayment penalty if you pay off your mortgage earlier than your payment plan specifies, or that you can only make the payments within specific limitations.
Prepayment penalties on mortgages can range from 2% to 1% of the loan balance in the first two years, and 1% beyond that. Knowing this information ahead of time might help you create a payback strategy that works for both you and your lender or servicer.
Think about alternative investments
Your most important decision may be whether to pay off your mortgage or invest. What if, instead of putting money into paying off your mortgage early, you spent it somewhere else?
Mortgage rates are lower than they have been in recent years, therefore if paying off your mortgage early results in a return equal to your interest rate, that return is likely to be insufficient when compared to the annualized return of an alternative investment.
Possibly a better use of the funds could be to leverage the cash you’d spend to pay off your mortgage into purchasing a cash flow-positive property, such as multi-family real estate or single-family homes, which have the potential to provide higher long-term returns.
Any option, though, is fraught with danger. Even if you pay off your mortgage early, real estate prices may fall, leaving you with a loss. Consider carefully which dangers you are willing to take. In the end, you might be better off not paying off your mortgage early.
Look at Liquidity
Before you take a substantial portion of your wealth and use it to pay off your mortgage early, consider liquidity. Because it can sometimes take up to several months or even a year to sell your home and access the funds, it is classified as a non-liquid asset.
One strategy is to keep emergency cash on hand, as well as assets such as stocks, mutual funds, US Treasuries, bonds, and marketable securities in a taxable investment account.
That way, in addition to having money in tax-advantaged retirement accounts and your property, you’ll have some liquid cash or other investments that can be easily converted to cash in an emergency.
How else would you spend the money?
Be honest with yourself about what you’re going to do with your funds if you don’t use it to pay off your mortgage early or in full. Will you truly use the money you save when you pay off your mortgage?
If you have trouble keeping money in the bank, it can make sense to put the money toward paying off your mortgage early. Making extra mortgage payments can save you hundreds of dollars in interest over time while also allowing you to develop equity in your home faster.
How much better will it make you feel?
It is sometimes more important to have peace of mind than it is to have a good bottom line. If you own your house outright, you can reap benefits that cannot be quantified in monetary terms. When considering living on a fixed income, many people find that reducing a monthly mortgage payment prior to retirement can bring emotional peace.
A further possible benefit is the option to borrow on your home’s equity. A significant amount of equity can enable you to create a home equity line of credit (HELOC), which can provide a source of emergency income while also allowing you to undertake home modifications or advance toward other financial goals.
Pros:
– Eradicates your monthly mortgage payment, freeing up some cash that can be put to good use, particularly during retirement.
– You might save thousands of dollars in interest by doing so.
– Can earn a consistent rate of return equal to the interest rate on the sum you’re paying off
– It gives you peace of mind to know that you own your home outright.
– If you need money later, you can use the equity in your property.
Cons:
– It ties up a significant portion of your liquidity and net worth in your property, which may make it difficult to retrieve later.
– The federal mortgage interest tax deduction is no longer available.
– It is possible that you will miss out on potentially higher profits from other investments.
– If the market dips and you have to sell soon, you may not get as much money from your house as you had intended.
Conclusion
While deciding if to pay off your mortgage in full or early, evaluate what actually works for your position and is almost sure to benefit you and help you to meet your short- and long-term financial goals.
When it comes to financial planning, it’s not always a direct judgment of what’s best by the numbers. People want to know where their money is going. For some individuals, owing money generates a lot of stress and general unease, and paying off a mortgage early can provide relief.
A paid-off mortgage means that when a person reaches state pension age, they will have that much more free cash flow from their fixed income after they stop working.
