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Buying a home is often the largest purchase you’ll make in your lifetime and comes with a long-term financial commitment. For many years, you’ll owe monthly loan payments as well as homeowners insurance and property taxes, depending on the terms of the loan and the state in which you reside.
The mortgage lender charges interest for a home loan, which is embedded in your payment. The total interest cost of a mortgage can inflate the cost of buying a home by tens of thousands of dollars over the years.
Paying off your mortgage early offers many benefits, including improving your monthly budget since you will no longer have a mortgage payment. Repaying your mortgage also provides financial security and flexibility, which can help if you lose your job or experience a loss of income.
However, there are drawbacks to repaying your mortgage early, including the opportunity cost of putting that money to use elsewhere. Discover the pros and cons of repaying your mortgage loan and tips on how to do it.
Key Takeaways
- Paying off your mortgage early can save you tens of thousands of dollars in interest.
- Paying off your mortgage early provides peace of mind since you own your home free and clear.
- A smaller monthly cash outlay helps alleviate concerns about unemployment or underemployment.
Paying Off Your Mortgage Early: The Pros and Cons
Paying off your mortgage can provide financial benefits, but there are other factors to consider before committing a significant amount of funds to becoming mortgage-free.
Pros
The first and most obvious benefit to paying off your mortgage early is that you can save tens of thousands of dollars in interest. Review your loan documents from when you bought the home since they should include a payment or amortization schedule, showing the principal and interest breakdown and the total interest cost.
Mortgage lenders disclose up front that you will pay more than the purchase price of the home before you actually own it. In some cases, the total interest cost can add up to an amount that is near or exceeds the original loan amount. Even shaving off several years of a mortgage by paying it down can save you thousands of dollars.
Another benefit to paying off your mortgage early is the peace of mind you gain from owning your home outright. You’ll have a lower monthly cash outlay, which allows you to put that money into savings, make purchases, and lower your financial stress in case of unemployment or underemployment. Alternatively, you can now afford to take a job that pays less than your previous position without any concerns about the lender repossessing your home through foreclosure due to nonpayment of the loan.
Paying off your mortgage provides a return on your investment if the home increases in market value over time. Also, if you’re worried about the cost of future home repairs, you have the financial flexibility of tapping into your home’s equity.
With a home equity loan or home equity line of credit (HELOC), you can take out a much lower amount than the original mortgage. Also, since a HELOC is a line of credit, you don’t need to make a payment unless you borrow, meaning you can have the HELOC remain open in case you need it for emergencies.
Cons
Some argue that paying off your mortgage is a bad financial move. They claim that you will get a higher return, in the long run, if you invest your money instead of making extra mortgage payments. While there is some chance that you will achieve such a feat, there’s also a chance that you won’t.
You’ll need to weigh the benefits of guaranteed savings in mortgage interest with the possibility of achieving a higher rate of return in the markets. However, there are risks associated with investing that can lead to losing all or a portion of the money you invested.
Of course, most people buy a home so they have a place in which to live. Even if it doubles or triples in value, they aren’t likely to sell it unless they downsize. Since you can’t live in a mutual fund, most home shoppers don’t make their purchase in an effort to beat the return of the S&P 500.
The next argument against paying off your mortgage is that you’ll lose the tax break from deducting mortgage interest. While technically this is true and you spend $1 in interest to get a 25- or 35-cent tax break, it only works if you a) itemize deductions and b) are in the highest income tax brackets.
For the average person, you’re likely to have a standard deduction allowed by the IRS, which reduces your taxable income. This tax break can offset some or all of the loss of the tax benefits from the mortgage interest deduction. Please consult a tax professional to determine the best tax strategy for you before paying off your mortgage.
Plan Before You Buy
Look before you leap and do the math in advance to determine how much house you can afford. One strategy is to buy less house than you can afford to ensure that you have adequate cash flow to make extra mortgage payments.
Also, it provides some cushion should you have to take a lower-paying job in the future. Also, check to ensure that your mortgage does not impose a penalty for prepayment, which can put a damper on your efforts to get out of debt.
Next, be aware of the loan’s financing terms since there are many types of mortgage products. For example, adjustable-rate mortgages (ARMs) offer lower initial payments, but the interest rate can reset higher later in the loan term. ARMs have been used to help buyers get into homes they cannot actually afford and when interest rates rise, some homeowners are caught unprepared.
Similarly, homebuyers often plan their finances based on the idea that their mortgage payments won’t change. This isn’t always true since your local government can raise your real estate taxes. If you want predictability, a fixed-rate mortgage provides a steady mortgage payment and interest rate and can be refinanced if rates fall.
How to Pay Off a Mortgage Quickly
Strategies for paying off your mortgage early include making bimonthly payments, which results in one extra payment per year. It’s a great strategy, unless there is a fee associated with it. If there is, you can simply set aside some cash and make an extra payment on your own.
If your career advances over the years, put those raises and bonuses to work by sending them to the mortgage company. You were doing just fine without that money, and you won’t miss it if you don’t get used to having it in your budget.
Keep an eye on interest rates and, if they fall, consider refinancing. If you can reduce your interest rate, shorten the term of your loan, or both, refinancing can be an excellent strategy. Just don’t make the mistake of keeping your term the same and taking money out.
A mortgage calculator is a good resource for comparing these costs.
Are There Tax Advantages to Paying Off Your Mortgage Early?
Typically, borrowers can or get a tax deduction for the amount of mortgage interest paid each year on their loan. If you pay off your mortgage early, you lose this tax deduction, which can increase your overall tax liability.
However, most taxpayers can take the standard deduction offered by the Internal Revenue Service (IRS). So, losing the mortgage interest tax deduction may not impact your overall tax liability. Please consult a tax professional before paying off your mortgage to discuss the financial and tax implications.
What Is the 2% Rule for Mortgage Payoff?
The 2% rule for a mortgage payoff involves refinancing your mortgage. Refinancing is when you take out a new loan to pay off your existing loan—ideally at a lower interest rate.
The 2% rule states that you should aim for a new refinanced rate that is 2% lower than your current rate on the existing mortgage. In this way, you save enough money in the long term to offset the cost of refinancing, which can include fees and closing costs.
Do Your Property Taxes Decrease When You Pay Off Your Mortgage?
Whether or not you have a mortgage loan has no impact on the cost of your property taxes. Typically, your property taxes are calculated based on the home’s value and the square footage of your property. In other words, your state or local government determines the value of your property through its tax assessment process.
The Bottom Line
There’s no time like now to begin assessing whether to pay off your mortgage early. Start by reviewing your amortization schedule and the total interest cost of the loan. Check your finances to determine whether you can afford to make extra payments. If you can, every extra dollar you send to the lender reduces the total interest. Ideally, at some point, you’ll find the comforts of home are even more pleasurable when it is you, not the bank, who owns your home.
