It can be tempting to pay off your mortgage early, especially if you have the funds readily available. You can retire debt-free, save on interest and even divert those savings to higher-earning investments.
There are some bad things about paying off your mortgage early, though, and it’s not always the best idea. If youre looking to free up cash, a mortgage refinance may be a better option.
If you decide to go the payoff route, there are a few things you should think about first. Heres what to think about.
What are the Pros and Cons of Paying Off Your Mortgage Early?
Paying off your mortgage early can seem like a great idea Who wouldn’t want to own their home free and clear and stop making monthly mortgage payments? While an early payoff can certainly be rewarding, it’s not the right move for everyone There are pros and cons to weigh when deciding if accelerating mortgage payoff aligns with your overall financial goals.
The Benefits of Paying Off Your Mortgage Early
Paying off your home loan ahead of schedule offers several potential advantages:
Peace of Mind
For many people, paying off their mortgage early is worth it because they feel safe and proud when they own their home outright. Getting rid of mortgage debt can give you peace of mind, especially if you are retired and living on a fixed income.
Interest Savings
When you pay off your mortgage faster, you reduce the amount of interest you pay over the life of the loan. Depending on your mortgage balance, interest rate, and payoff timeline, you could potentially save thousands in interest expenses.
Built Home Equity
Making extra mortgage payments builds your equity faster. With substantial home equity built up, you can more easily access funds in the future through options like a cash-out refinance or home equity loan.
More Cash Flow
When you finally pay off your mortgage, you can use the extra money that you used to pay your monthly bill for other things. You’ll have extra money that you can use for important things like investments, road trips, retirement savings, or college funds.
Potential Drawbacks of Early Mortgage Repayment
While the benefits can be substantial, paying off your home loan early also comes with some potential limitations:
Lost Tax Benefits
It is no longer possible to deduct mortgage interest from your taxes once the loan is paid off. Some homeowners can save a lot of money on their taxes every year with this deduction.
Reduced Liquidity
Extra payments tie up money in your home, reducing the liquid cash you have available for other needs. Accessing home equity can take time. An early payoff may limit your flexibility.
Opportunity Cost
If you put extra money toward your mortgage instead of investing, you might miss out on higher returns on your money if your mortgage rate goes up. Crunching the numbers is key.
Higher Monthly Cost
If you refinance to a shorter term to accelerate payoff, your monthly payments will increase. Make sure you can comfortably handle the higher cost.
Prepayment Penalties
Some mortgages impose prepayment penalties if you pay off the loan early. Be aware of any fees your lender may charge.
Should You Pay Off Your Mortgage Early?
Deciding if accelerating your mortgage payoff is the right move requires weighing all the pros and cons in the context of your personal financial situation and goals. Here are some key factors to help determine if it makes sense:
Your Interest Rate
The higher your mortgage rate, the more interest you’ll save by paying off the balance faster. Weigh early payoff carefully if you have a low rate.
Your Emergency Fund
Don’t pay extra toward your mortgage at the expense of emergency savings. Build a solid emergency fund first before considering extra mortgage payments.
Other Investment Options
Run the numbers to see if those extra funds would earn higher returns if invested elsewhere instead of going toward mortgage principal.
Your Income Stability
If your income fluctuates a lot, maintaining liquid savings and keeping mortgage payments lower may be a better option than tying up cash in home equity.
Your Tax Situation
Calculate the impact on your tax bill if you lose the mortgage interest deduction. The lost tax savings could outweigh interest savings from an early payoff.
Your Other Debt
Pay off high-interest credit cards and other debts before putting extra funds toward lower-rate mortgage debt. This will save you more on interest overall.
Your Financial Goals
Make sure an early mortgage payoff doesn’t compromise other important goals like retirement, college savings, or travel plans. Prioritize goals wisely.
Strategies for Paying Off Your Mortgage Early
If accelerating your payoff aligns with your financial situation, here are some proven strategies:
Bi-Weekly Payments
Making half your normal payment every two weeks saves interest and pays off the loan faster. Automate payments for ease.
Add Extra Each Month
Determine an extra amount you can afford monthly, like an additional $100 or $200, and have it automatically applied to your mortgage principal every month.
Annual Lump Sum
Use your annual bonus or tax refund to make a lump sum payment once a year to bring down your mortgage principal.
Refinance to Shorter Term
Refinancing into a shorter loan term means you’ll pay the mortgage off faster. Run the numbers to see if lower costs outweigh the higher payment.
Make One Large Lump Sum
If you receive a windfall like an inheritance, you could opt to put it toward one large lump sum payment and drastically accelerate your payoff timeline.
The Takeaway
While paying off your home loan early offers some financial benefits, it’s not the optimal choice in every situation. Look at the big picture of your overall finances and goals. A mortgage pro can help assess if an accelerated payoff aligns with your needs and advise customized strategies to implement it successfully. With expert input, you can determine the smart way to handle extra funds.
Con: You lose a tax deduction
Homeownership comes with quite a few tax advantages. One of the biggest is the mortgage interest deduction, which allows you to write off the interest you pay toward your mortgage loan each year — as long as your balance is $750,000 or less.
When you pay off your mortgage, you forgo this valuable deduction, and it could increase your taxable income quite a bit.
A quick note: The mortgage interest deduction is only available if you itemize your returns. For many homeowners, taking the standard deduction (instead of itemizing) is more beneficial. The current standard deduction is $12,950 to $25,900, depending on your tax filing status.
Con: You may have to pay a prepayment penalty
Potential prepayment penalties are another drawback to consider. Some lenders charge fees if you pay off your loan too early, as it eats into their ability to make a profit.
These fees vary, but generally, its a small percentage of the outstanding loan balance. These penalties are typically only charged if youre very early on in your loan term — usually within the first three to five years, according to the Consumer Financial Protection Bureau. Not all mortgage lenders charge prepayment penalties, though, so make sure to check with yours if youre considering paying off your loan in full.
Pros and Cons of Paying Off Your Mortgage Early
FAQ
Is there a downside to paying off your mortgage?
Peters explains that the biggest potential downside to an early mortgage payoff is what’s called opportunity cost. “If you use extra money to pay off your mortgage early, you might miss out on chances to invest that money and possibly make more money, especially when the market is strong,” he says.
Is it better to pay off a mortgage or leave a small balance?
The usual answer is that paying down the mortgage is better for your finances, but rates are going up and some people have very low mortgage rates right now. You can easily make a small spread with no risk and give you more down payment on your next home compared to just paying down on the home.
Does Dave Ramsey recommend paying off a mortgage?
Dave Ramsey, the renowned financial guru, has long been a proponent of financial discipline and savvy money management. This can include paying off your mortgage early, but only under specific financial circumstances.
What is the 2% rule for mortgage payoff?
The “2% rule” for a mortgage payoff suggests aiming for a new refinanced 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.