Should You Pay Off Your Mortgage Early?
Does it make sense to pay off your mortgage early when you can afford it? Or is it best to stick with your normal monthly repayments until the loan term is done?
It is normal to have the desire to pay off your mortgage as soon as possible than wait for a decade or so to complete the repayments. However, before squandering a windfall or an inheritance towards your mortgage, the experts recommend taking a step back to review the possibilities.
Benefits of Paying Off Your Mortgage Early
Whether you want to pay off your mortgage early to save on interest, to gain the perfect credit score or to simply have peace of mind, there are certain benefits to paying off your mortgage early. Here are some potential benefits:
- Thousands of dollars worth of interest savings over time
- Lower monthly expenses
- More cash available for retirement or other investments
- More cash available to save for college tuition
- Usable equity in case you need cash in the future
- Improved credit score (because of on-time and advanced mortgage payments)
- Priceless peace of mind knowing that you are debt-free
Disadvantages of Paying Off Your Mortgage Early
Paying off your mortgage can also come with several disadvantages including the following:
- It can be challenging to access that equity again if you need cash
- You may miss out on better opportunities to earn through investments
- Real estate market changes may decrease the value of your home
The benefits truly outweigh the disadvantages of paying off your mortgage early but it is always smart to go through the checklist and weigh your options first.
The Basics of Paying Off Your Mortgage Early
Paying off your mortgage early is a good way to reduce the total interest you will need to pay over time, especially if you have a high interest or an adjustable-rate loan. For some, directing all of your funds to clear the mortgage might be well worth it if you are able to save a significant sum on the interest.
For homeowners who would like to pay their mortgage earlier, there are several ways to do this. Provided the lender doesn’t charge extra for additional payments, you can increase the monthly payments or send 13 checks (or more) per year instead of the usual 12. By consistently increasing monthly mortgage payments, homeowners will eventually be able to fully pay their homes at an earlier timeline.
This is also done by sending payments every two weeks instead of just once per month. In the end, you will make extra payments over the course of a year.
Expert Views on Paying Off Your Loan Sooner
Experts have conflicting views when it comes to eliminating your mortgage debt. Popular money management expert Dave Ramsey emphasizes the need to fully pay mortgages (in addition to all other debts) for better financial freedom and security in the future.
On the flip side, another personal finance expert, Ric Edelman, suggests that one should ‘never’ pay off their mortgage. According to Ric, a mortgage is one of the ‘cheapest money’ opportunities you will ever have.
While these two perspectives each have their own merit, the decision to overpay your mortgage (or not) ultimately depends on your personal circumstance. To some, paying their mortgages early makes sense, while for others, it may not, given their current financial situation.
This video will walk you through some viewpoints on paying down the mortgage early.
Things to Consider When Planning to Pay Your Mortgage Early
If you are thinking of paying off your mortgage early, here are a few things you should consider:
1. Existing debt.
Do you have other existing debt? If you have existing ‘expensive’ debts, you may need to pay them off first before deciding to increase your mortgage-payment efforts. Expensive debts are those that tend to rack up the highest interest rates over the course of the year. Examples of expensive debts include unpaid:
- Credit card and store card bills
- Unsecured loans
- Auto/car loans – Read[getting a mortgage with a car loan]
- Student debt (especially the refinanced ones)
- Home equity lines of credit
It’s advisable to settle these accounts first before focusing your energy on advance mortgage payments. Read [getting a mortgage with a car loan]
2. Your retirement funds
If you have money to spare but don’t have a pension plan in place, now is a good time to start one. Having a retirement vehicle like a 401k is a tax-efficient way to save. The government includes tax relief for some retirement plans, while some employers may also add matching funds.
In addition, the earlier you start building your retirement nest egg, the more you will see it grow over time. You should at minimum consider contributing up to the employer match before paying down your mortgage.
3. Savings and emergency funds
Experts suggest having a 12-month emergency fund enough to cover your utility expenses in the event of an untimely situation (I.e. lay-offs, accident, illness). Putting your financial attention on mortgage payment but sans an emergency fund as a safety net may leave you in dire financial problems if such untimely events occur.
In addition, it’s important to save 20% of your gross income at the bare minimum before putting your extra income into your mortgage payments. And if you can find a savings rate that is higher than your mortgage interest rate, applying your money to that savings may be more worth it than putting everything to paying off your mortgage.
4. Upcoming large but necessary purchases
The last thing you want to be is in further debt in your attempt to complete your mortgage payments, especially if you are anticipating major expenses in the foreseeable future. If you’re planning to:
- Remodel your home
- Purchase a new car
- Have an expensive vacation
- Save for your child’s education
- Get married
You may need to rethink putting your efforts on mortgage payments if you have other priorities to consider.
5. Investment opportunities
It’s also good to consider whether the return of paying off a mortgage is greater than putting the same amount of money under different investments. If you are planning to pay off your mortgage, you can expect a return of roughly the equivalent of the current mortgage interest rate (around 3.5 to 5.5%). In comparison, the S&P 500 index fund’s annualized return is around 10% over the last 9 decades.
Other investment opportunities may also be more lucrative than paying off your mortgage. Directing your funds into a business or investing in renting out real estate may be better choices than a mortgage pay-off from a profit perspective.
Mistakes to Avoid When Overpaying Your Mortgage
After you have considered the above options and still decide to pay off your mortgage, just make sure to avoid the following common mistakes:
● Not considering if there is a prepayment penalty
This is one of the most obvious mistakes you can make when attempting to fully pay your loan. Make sure to check if your lender charges pre-payment fees before sending an extra check or increasing your monthly payments. That said, most primary residence mortgages no longer have pre-payment penalties.
Lenders may at times charge additional admin or processing fees for making extra payments towards your balance. Therefore, you need to find out what the implications are before sending the extra payments.
If you have a home equity product you can easily make any size payment that you like without penalty and some people will actually use this like a bank account.
● Not specifying where the extra payments will go.
Make sure to direct all your extra payments into your loan principal; otherwise, the extra payments would not make much of a difference. Your lender may deduct your extra payments to your next month’s payment. You can make a note of where your extra payments will go.
● Putting all your cash into mortgage payments.
While it’s truly worth it to achieve peace of mind by eliminating your mortgage debt, it may be unwise to leave yourself cash poor in your attempt. Before putting every penny you have into mortgage payments, it’s important to set aside an emergency fund to cushion any possible financial blows you may encounter while trying to complete your mortgage payments.
Don’t try to pursue extra mortgage payments without having a sound backup plan to see you through in times of financial difficulty.
Other Tips to Help Payoff Your Mortgage Early
- Pay off high-interest debts first. If you have existing credit card, car or personal debts, make sure to tackle them first before paying off your mortgage. Also, these debts are not tax-deductible, so getting rid of them is a priority. You can always get a debt consolidation loan and then have just one low interest mortgage to repay.
- Consider bi-weekly payments. Bi-weekly payments work exactly as it sounds. By setting up bi-weekly instead of monthly payments, you’ll end up with 26 payments a year, which easily translates to 13 months’ worth of payments (instead of 12). You can set this up with your lender, but if they’re not open to this, open a separate bank account to save your bi-weekly payments.
- Have a financial safety net by building your savings and emergency funds first. Putting this in place will allow you to access some funds in case of emergencies.
- Make budget cuts and increase income. One aggressive way to deal with your mortgage is to make room for your additional mortgage payments in your budget. This means adding more income and creating significant spending cuts and directing these extra savings into your mortgage payments.
Should You Pay Down Your Mortgage Faster?
Getting rid of your mortgage is truly a big relief, because who wouldn’t want to become debt-free? However, it’s a major financial choice that requires your full commitment and the implementation of various strategies to pay down your mortgage.
Before deciding to pay down your mortgage faster, make sure you re in good financial shape with enough reserves to get you through a financial crisis. Make sure you weigh the pros and cons of paying down your mortgage and think about all of the other options you may have.
Refinancing for Home Improvements – Some people are actually cashing out and taking out a larger mortgage to pay for things like home improvements.
Debt Consolidation Mortgages – If you have a lot of high interest debt, you may want to consider consolidating it all into one loan.
The Best Mortgage for First Time Home Buyers – If you are wondering what to do as you are shopping for your first home, this article will provide you with the insight needed for your first mortgage.