It might seem like a good idea to pay off your mortgage early if you have the extra money. But is an early mortgage payoff always the right move? Ryan Peters, Wealth Planner with U. S. Bank Private Wealth Management, shares how to determine if it’s right for you to pay off your mortgage or invest extra cash in another way.
Paying off your mortgage early can be a great way to save money on interest and build home equity faster, But when’s the best time to make that final payment – the beginning or end of the year? There are pros and cons to both options
The Case for Paying Off Your Mortgage at the Beginning of the Year
Here are some potential benefits to paying off your mortgage in January or early in the year:
1. You can start the year debt-free
What better way to start a new year than to get rid of your biggest debt? If you pay off your mortgage at the beginning of the year, you’ll have a clean slate and 12 months to enjoy not having a mortgage. This sense of freedom and financial security can be very motivating.
2. You get a full year of tax savings
If you list your deductions on your tax return, you can’t deduct mortgage interest if you pay off your mortgage early. If you pay it off in January, you get the biggest tax break for the interest you paid the year before. After that, you can’t get the deduction anymore for the rest of the year.
3. You can adjust your escrow payments
When you pay off your mortgage, you no longer need to make escrow payments for property taxes and insurance as part of your monthly payment. Paying off your loan early in the year gives you more time to work with your lender to adjust your escrow account and potentially get a refund.
4. You can use your house as collateral for a HELOC
With your mortgage paid off, you can take out a home equity line of credit (HELOC) against the equity that’s now built up in your home. This gives you access to funds in case of an emergency. If you pay off your mortgage early in the year, you have the full 12 months to get a HELOC set up if needed.
5. It aligns with New Year’s resolutions
It can be very satisfying to finally reach your goal of paying off your mortgage. Getting it done at the beginning of the year fits with the idea of making New Year’s resolutions and starting over.
The Case for Paying Off Your Mortgage at the End of the Year
Paying off your mortgage in December or late in the year also has some potential perks:
1. You get the full mortgage interest tax deduction for the year
If you wait until the end of the year, you can deduct as much mortgage interest as possible on your taxes before the deduction goes away in the following years. This can lead to some significant tax savings.
2. You have more time to save up the payoff amount
For some homeowners, coming up with enough cash to pay off their mortgage early takes disciplined saving over many months or years. Paying it off later in the year allows more time to build up funds in the current year before making the final payment.
3. Your financial situation may improve throughout the year
Maybe you’re anticipating a bonus or other windfall later in the year that will provide the funds you need to pay off your mortgage. It makes sense to wait until that money comes in before making the final payment.
4. You give yourself more time to consider the decision
For a big financial move like paying off your mortgage early, it can be wise to give yourself plenty of time to consider all the pros, cons and alternatives. Waiting until late in the year provides more time for reflection.
5. Your mortgage balance will be lower
Since mortgages are amortized, your balance declines each month as you make payments. Paying it off later in the year means you have to come up with a slightly smaller payoff amount than you would earlier in the year.
Key Factors to Consider
When deciding between paying off your mortgage at the beginning or end of the year, keep these key factors in mind:
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Your tax situation – Do you claim the mortgage interest deduction? How much savings does it provide?
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Your payoff amount – Do you have the cash on hand already? If not, how long will it take you to save it up?
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Your plans for equity – Will you take out a HELOC or need to access equity soon after paying off the mortgage?
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Your comfort level – Do you prefer ripping off the bandaid or giving yourself more time to get used to the idea?
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Interest savings – Use a mortgage payoff calculator to estimate savings for beginning vs. end of year.
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Your lender’s requirements – Are there any limitations on when you can make the final payment?
Tips for Paying Off Your Mortgage Early
If you’ve weighed the pros and cons and decided you want to pay off your mortgage ahead of schedule, here are some tips:
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Make payments biweekly instead of monthly to save faster.
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Use windfalls like bonuses or tax refunds to make extra principal payments.
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Refinance your mortgage to a lower rate so your regular payments pay off the loan sooner.
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Cut discretionary spending to free up more cash that you can put toward your mortgage.
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Recast your loan after a large principal payment to lower your monthly payment.
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Discuss your plans with your lender to make sure there are no prepayment penalties or restrictions.
The Bottom Line
There’s really no one “right” time to pay off your mortgage – it depends on your specific situation. But now that you know the potential benefits to paying off your loan early in the year versus later in the year, you can choose the option that aligns best with your financial goals. The key is being mortgage-free!
Disadvantages of an early mortgage payoff
Though paying off your mortgage early may seem like a win-win scenario, there can be potential downsides. It’s important to examine any potential penalties or negative financial impacts before taking the leap. These can include:
- Opportunity cost. Peters explains that the biggest potential downside to an early mortgage payoff is what’s called opportunity cost. “If you use extra cash to pay off your mortgage ahead of time, you may miss out on opportunities to invest that money and potentially earn a higher return, especially in a strong market,” he says.
- Reduced liquidity. Making extra payments towards your mortgage naturally means you’ll have less money readily available for emergencies or unexpected expenses. Peters emphasizes the importance of having a solid emergency fund in place before considering an early mortgage payoff (more on this below).
- Credit score impact. It may sound counterintuitive, but paying off any debt in full can cause your credit score to take a hit, and a mortgage is no exception. “When you pay off your mortgage, you simultaneously decrease your credit mix and credit age,” explains Peters, “which may cause your score to drop.” However, this decrease is likely to be minor, and for some, the peace of mind that comes from paying off a mortgage may be more important than this number, especially your score was good in the first place.
The benefits of paying off your mortgage early
Paying off your mortgage comes with some undeniable perks. When you no longer have that monthly payment hanging over your head, you’re likely to benefit from the following:
- Peace of mind. For many people, peace of mind is the number one reason they decide to pay off their mortgage early. “Especially if someone is retired and without steady employment income anymore, if they have the means to pay off their mortgage, it might feel like a weight off their shoulders,” says Peters.
- Saving on interest. Another big draw for people considering an early mortgage payoff is how much they’ll save on interest. By shortening your loan term, you’ll significantly reduce the total amount of interest you pay over the life of a mortgage. If you have a particularly high interest rate on your mortgage, this might be a compelling reason to pay it off early.
- Building equity. The faster you pay down your mortgage, the faster you build equity in your home. “If, down the road, you want to borrow against your home – whether to make home improvements or to pay off high interest debt – you can tap into this additional equity through a home equity loan or line of credit,” Peters says.
By eliminating the cost of your monthly mortgage payments, you’ll also free up funds to invest in other financial goals.
Should You Pay Off Your Mortgage Early or Invest? | Financial Advisor Explains
FAQ
What is the 2% rule for mortgage payoff?
If you want to pay off your mortgage quickly, the 20%222% rule says to try to get a new interest rate that is 2% lower than your current rate. This helps ensure that the savings generated by refinancing outweigh the costs associated with it.
When should you not pay off your mortgage early?
If you have little cash saved up, you might not want to pay off your mortgage early. You don’t want to become house rich but cash poor by paying off your home loan early and using your savings. We recommend keeping a cash reserve of three to six months’ worth of living expenses in case of emergency.
What is the 10/15 rule for mortgages?
The 2010–15 Mortgage Rule: Make an extra payment each week equal to 10% of your monthly mortgage payment, payable to the principal. For example, if your monthly mortgage payment is $2,000, you ought to pay an extra $200 every week, and by doing that, reduce your loan term by 15 years.
What does Dave Ramsey say about paying off your mortgage?
Opportunity costs To be fair, Ramsey does not advise paying off your mortgage as a first step. He wants you to pay off all of your other debt first and then start setting aside 15% of your money to stick in mutual funds. Only after you do these things does he tell you to pay off your mortgage.