Ben Todd | Jun 2, 2017 | 1
Should You Pay Your Mortgage Off Early
Paying off your mortgage early can have benefits, as you pay down your debt, however there can be risks associated with it, as well investing opportunities you could miss out on. This article will explain both sides of the argument, giving you more information on whether you should pay off your mortgage early.
Reasons Why You Shouldn’t Pay Off Your Mortgage Early
One points states that you should not pay your mortgage off early, especially if you have a low interest rate. This is because you could invest your money in the stock market where you can have earned 6%-10% with a well balanced portfolio over the course of 10 years or so. It is basic math, as it does not make sense to pay off a loan 3-4% when you could be using that money to earn 6-10% interest from investments.
Furthermore, you can also take advantage of a tax deduction called the home mortgage interest deduction. This deduction allows homeowner to deduct some of the interest that is paid on any loan that is used build, purchase, or to make improvements on the house.
The best way to figure out what your home mortgage interest deduction will be is to first look at your effective tax rate. For example, lets say your overall tax rate is 25%, on average the home mortgage interest deduction reduces your taxes $25 for every $100 you pay in interest. That is a pretty good incentive to hold on to your mortgage. But theres a catch, your home mortgage interest deduction is only valid for the amount that you deduct over and above the standard tax deduction, which is available to all tax payers who don’t itemize their returns. Basically what this means is if you don’t itemize your taxes, then your home mortgage interest deduction is really worth nothing.
Reasons Why You Should Pay Off Your Mortgage Early
Now on the other hand, it is said that you should pay off your mortgage early because your goal should be to pay off your debt as soon as possibly so you can achieve financial freedom. It is argued that there are risk associated with investing the mortgage in stocks. Yes, the stock market on average produces good returns but nothing is guaranteed and a bear market could wipe out most of the returns at any time. It’s always everybody’s goal to be debt free regardless of the situation.
Many do not like the idea of investing as the are worried the investments will not generate adequate returns. They argue that after you pay off your mortgage, you can just use that money to invest in stock, mutual funds, etc. However what they don’t take into account is if you reduce your 25 year mortgage to 15 years, you will have lost 10 years off earnings from compound investment earnings.
Another argument for paying off your mortgage early is you will save money on interest if your pre pay your mortgage. Many people are fine with the strategy off prepaying their mortgage and banking the money they would be paying on interest charges. Even if its less then what they could have earned investing the money instead.
If you pay off your mortgage early, a large amount of your net worth will be tied up in your home. This can also be risky, as the real estate market has its ups and downs, and if you sell your house when the real estate market isn’t doing very well, you could lose money.
The Balanced Approach
If you are unsure what to do, you can use the balanced approach. This involves paying off your mortgage slightly early so you are out of debt, and in the meantime using the mortgage to invest and earn profits higher then the interest rate you are paying. You can be really flexible with a balanced approach. Some strategies involve maxing out your retirement accounts first, then paying off an extra few hundred dollars on the mortgage each month.
Can You Afford It?
If you are one that really wants to pay off your mortgage as quick as possible, you have to take into account how much larger your mortgage payments are going to be. Let’s say you have a 25 year mortgage that you want to pay off in 15 years instead. It is going to cost you an extra $300 to $500 more a month depending on your interest rate. You have to take into account all your expenses and see if you can afford spending hundreds of dollars per month.
If you decide to pay down your mortgage early, you should have lots of extra cash saved so that you are not spending all of your savings on paying down your mortgage early. If you start with the early payoff of your mortgage then stop, realizing you can’t afford it then you will have even more money in your home then you do now. This is something that is called dead equity since it doesn’t equate to any benefit.
You should only consider paying off your mortgage early if know you will have no problem following through and getting the entire mortgage paid off. If you think you can do it but it will be tight, then it is recommended not to follow through with this plan.
The Final Word — What to Do
There are risks involved in both paying off your mortgage early, in the form of opportunity missed from investing in the markets, as well as risks in not paying off your mortgage early and taking a chance on stocks that always have some risk. Everybody is different so everybody will have their own preferences and there is nothing wrong with that.
If your are someone who tolerated a little bit of risk well when investing with the mortgage, then do not pay it off. However, if you are someone who needs peace of mind, who doesn’t like being in a state of debt then by all means, pay off your mortgage early.