A mortgage is the single biggest form of debt most of us will ever have. A typical homeowner faces a mountain of payments that add up to hundreds of thousands of dollars over the life of a home loan.
"I am a big fan of paying off one's mortgage – not from a financial standpoint, but from a peace of mind standpoint," says Thomas Balcom, a Florida-based certified financial planner and founder of 1650 Wealth Management. "Not having a mortgage payment is a good stress reliever."
However, while paying off the mortgage can be the right move for many, it's not for everyone. It's important to understand the pros and cons before you pursue this path.
Advantages of Paying Off Your Mortgage Early
You free up room in your budget. By paying off the mortgage, you eliminate what is likely your biggest monthly expense. That gives you financial breathing room.
You reduce the cost of mortgage interest. By paying off your home loan, you can save thousands of dollars in interest over the life of the loan. "You are, at the end of the day, saving money by not having to pay interest, which is an expense," says Nicole Sullivan, an Illinois-based certified financial planner and co-founder and director of financial planning with Prism Planning Partners. "You're also eliminating an enormous amount of debt."
You save more for other things. Paying off the mortgage frees up money for other long-term goals, such as saving for retirement or traveling more often.
Disadvantages of Paying Off Your Mortgage Early
You have less cash for expenses. In the short run, money may become tight as you use more dollars from your savings and earnings to pay down the mortgage. "Make sure you can afford to do it without stressing your cash reserves," says Clark Randall, a certified financial planner and director of financial planning at Creekmur Wealth Advisors in Dallas. "You are placing a large amount of money in an extremely illiquid asset."
You may save less than you think. It's possible that paying off your mortgage will save you less in interest than you could gain by investing the money elsewhere. "Most who had mortgages before interest rates increased should be able to make a 5% yield in savings accounts and continue paying a 3% mortgage," says Anna Sergunina, a certified financial planner and president and CEO of MainStreet Financial Planning.
You might owe fees. With some mortgages, the lender might charge a prepayment penalty for early payoff. This cost can undercut some of the advantages of paying off the mortgage.
Mortgage rates marched upward this week to the highest level since 2000, according to the Mortgage Bankers Association. Both fixed and adjustable mortgage rates increased on the heels of the last Federal Reserve meeting, during which policymakers reiterated their position of keeping rates higher for longer.
Mortgage interest rates were widely expected to fall throughout 2023 but have remained elevated well into the third quarter of the year. Here are the current mortgage rates, as of Sept. 27:
30-year fixed: 7.41% with 0.71 points (previous week: 7.31% with 0.72 points).
15-year fixed: 6.73% with 1.17 points (previous week: 6.62% with 1.08 points).
5/1 ARM: 6.47% with 1.58 points (previous week: 6.42% with 1.1 points).
30-year jumbo loans: 7.34% with 0.78 points (previous week: 7.32% with 0.8 points).
30-year FHA loans: 7.16% with 0.96 points (previous week: 7.08% with 0.92 points).
Should You Pay Off Your Mortgage Early or Invest?
Your life circumstances and goals will help you determine whether paying off your mortgage early or investing the money is the right path forward. "Before paying off a mortgage, you should ask yourself: What are your goals?" Sullivan says. "Do you want to grow your wealth or have additional cash flow for spending needs?"
In some cases, it can make sense to invest extra money – in hopes of earning a higher return – rather than using it to pay down the mortgage. "Very simply, if your mortgage rate is, say, 3% and you can earn more – like 5% – on your money, it makes financial sense to keep the mortgage," Randall says.
Your stage in life might play a role in whether paying off the mortgage now is a good idea. For example, if you are nearing retirement, you might be more comfortable paying off the mortgage instead of putting the money in the stock market. "As a financial planner, I suggest trying to be debt-free and own your home in retirement," Randall says. "If you always have a place to live that is already paid for, you can get by on a reasonable amount of money each month."
Questions to Ask Yourself Before Paying Off Your Mortgage Early
Only you can decide whether it makes sense to pay off your mortgage early. Ask yourself the following questions:
Are your finances in good shape? Have you paid off high-interest debt, such as credit cards? Do you have enough money saved in an emergency fund?
What will you gain? Some people pay off the mortgage to free up room in their budget. Others want the peace of mind. Know what your goal is before you commit.
Will you pay a prepayment penalty? Some lenders charge a fee for paying off the mortgage early. If this applies to you, calculate the cost and decide whether paying off your home loan prematurely still makes sense.
Will it reduce your financial flexibility? Paying off the mortgage usually requires hundreds of thousands of dollars in early payments. Will doing this leave you with enough liquidity to cover other expenses?
Can you get a better return on your money? In many cases, you'll be able to make more money by investing – or even keeping the money in a high-yield savings account – than you would save paying down the mortgage. This is especially true if your mortgage rate is low.
Will you lose a key tax deduction? Some people deduct mortgage interest from their tax return. However, it's important to note that for millions of people, this tax break is not as attractive as it was before the federal Tax Cuts and Jobs Act of 2017.
Will you have less money for other things? By paying down the mortgage, you might have less money to save for retirement, your children's college education or other important goals.
How will life change? Think long and hard about the potential emotional and financial benefits – or drawbacks – of paying off the mortgage to help you determine whether it's the right move for you.
Ways to Pay Off Your Mortgage Early
If you're ready to pay off your mortgage, you can take steps to make the process easier:
Pay biweekly. When paying biweekly, you make half of your mortgage payment every two weeks instead of paying once monthly. Because each year has 52 weeks, you end up making one extra payment each year. "This extra payment goes directly toward reducing the principal balance of your mortgage, which in turn reduces the amount of interest you'll pay over the life of the loan," Sergunina says.
Budget for an extra payment each year. Another way to make an annual extra payment is simply save up the money through the course of the year, then make it as the year comes to a close. Some homeowners might prefer the flexibility of this approach.
Refinance and make bigger monthly payments. Right now, mortgage rates are high, and refinancing doesn't make sense for a lot of homeowners. But if things change – or if you have a high rate now – refinancing to a shorter loan term or adjustable-rate mortgage with a lower rate can save you money, which you can then use to make additional payments to pay down your principal. If you choose this route, make sure you clearly signal your intentions to your lender. "Make certain that you indicate that the extra payments are to be applied to principal," Randall says. "Otherwise, you may simply be prepaying future payments, which is not nearly as beneficial."
Make larger payments when you have the money. Balcom recommends making bigger payments whenever possible, then recasting your mortgage so it reduces long-term interest payments. With a mortgage recast, you make a lump sum payment on your mortgage, and the lender agrees to give you a lower monthly payment without requiring you to refinance. "This is the strategy that I utilized when paying off my mortgages in the past," he says.
-----
Source: usnews.com
Share:
Work With Jason
Drawing on his decade of experience in finance, investment management, and holistic financial planning, and as a Chartered Financial Analyst ( CFA ® ) charterholder, he leverages his financial acumen and analytical focus to help his clients navigate the sophisticated San Francisco market.
