Should you pay off your mortgage early?

Buying a home is one of the biggest financial decisions you’ll ever make. You’re looking at spending hundreds of thousands of dollars in principle and tens of thousands of dollars in interest.

That kind of investment can weigh on you and so, it only makes sense to want to pay it off early. But is that the right choice for you?

While the answer may seem straightforward, there are both pros and cons to consider when deciding if you should pay off your mortgage early.

The way that mortgages are structured, you pay off more interest at the beginning of the loan and less at the end of the loan. If you pay extra on your mortgage principal, you’ll reduce the amount of interest that accrues, and therefore end up paying less in interest overall — because you’re reducing the principal that would accrue the interest.

Doing this over time knocks years off your loan. And it’ll save you thousands of dollars over the lifetime of the loan.

Say your house cost you $150,000. You agreed to a monthly payment of $1,200. If you increase your monthly payment by $300 a month, you could end up saving over $27,000 in interest. You’ll also shave years off your mortgage.

The math seems to make it an easy decision: of course you should pay down your mortgage to save that much on interest. Right?

Well, maybe.

Not all financial experts agree this is the best way to use your income. Some value investing over paying down your mortgage; others think prioritizing other debt is more important.

There’s no right or wrong answer here, and whether you pay off your mortgage early is a personal choice determined by your own specific circumstances.

Pros

• You’ll be mortgage-free — This is a huge motivator. You’ll own your home outright. You won’t have to worry about falling into foreclosure or someone taking your home away.
• You’ll save thousands on interest — If you want to pay as little interest as possible, paying off your home early is the way to go. In the example above, just $300 a month saved $27,000 in interest. That’s a huge chunk of change that you could put toward something you really want, like a new car.
• Your cost of living decreases — Your mortgage is often 30% of your expenses — or sometimes more depending where you live. If you’re not paying a mortgage, that frees up a third or more of your cost-of-living expenses.

Cons

• You might be missing out on money — According to the previous market returns, you can expect your money to grow 8% to 12% a year — except in recession years. You could be limiting your investing potential by paying off your mortgage instead of putting that money into the market.
• Your credit score could take a ding — When you pay off a large debt quickly, your credit score temporarily drops because a type of credit has disappeared from your profile. While your credit will recover, if you’re someone who likes having the best credit, paying off your mortgage slowly will actually help boost your credit score.
• You could be hit with prepayment penalties — Mortgage companies want their money. If you decide to pay off your mortgage before the allotted date, you might be hit with prepayment penalties that affect how much interest you’ve saved.
• Mortgage interest is tax-deductible — For most people, home mortgage interest is the single largest income tax deduction they have.

It’s important to consider all the different factors when it comes to paying off your mortgage early. These factors include your peace of mind, your cash flow, and what you could do with that money otherwise.

Peace of mind

The biggest reason people choose to nix their mortgage is for the peace of mind of not having to make payments anymore. Having a six-figure debt to your name can be daunting, and no one wants that. Paying off your mortgage early helps assuage some of the negative emotions you might feel about your debt.

It also allows you to own the home that you’ll be living in. You still need to pay for upkeep, property taxes, and other expenses, of course, but you won’t ever have to worry about the bank coming and taking away your home. That, to me, is a huge draw to paying off your mortgage early.

Cash flow

While it’s an enticing idea to get rid of your mortgage quickly, it might not be the best option if it negatively affects your cash flow. Look at your budget and see what’s available to you. If adding an extra $200-$300 to your mortgage at a time is a stretch, then paying off your mortgage might not be the right decision.

Similarly, people often assume that paying off your mortgage early means throwing a large lump sum of cash at it. If this appeals to you, you’ll want to ensure first that you don’t wind up cash-poor.

Instead, you need to focus on maximizing your cash flow. That means making sure all your bills are paid and you have a sufficient cushion for any emergencies. While those might not make as impressive a story as “I paid off my mortgage seven years early,” you don’t want to be caught in a situation where you’re having trouble making ends meet because of such an audacious goal.

If you do have extra cash to throw at your mortgage, go for it. But you never want to put yourself in an uncomfortable financial situation because something sounds like the right thing to do.

Net worth

By paying off your mortgage early, it’s likely that a large amount of your net worth will be tied up in your home. This comes with its own risks. Real estate is often considered a safer investment than stocks, but it’s not without risks. If you need to sell your home during a soft real estate market, you may lose money or, worse, be unable to liquidate at all.

Similarly, consider what would happen if a life event required you to come up with a lot of cash — more than you have in emergency savings. Imagine you become unemployed for many years, need extensive medical care, or decide to invest in a business. Stocks can be easily sold to finance such needs, but if your net worth is tied up in your home, you would either have to sell your home or rely on a home equity loan (going back into debt).

Instead, if you choose to pay off your mortgage early, make sure you have your buckets fully funded. That means your emergency fund is stocked up, and any other funds you’re working on filling.

The last thing you want to do is use your emergency fund to pay off that last couple thousand. Because the next thing you know, your HVAC is going to break — and you’ve got nothing left to pay the repairperson.

» MORE: Calculate and track your net worth with the Best Net Worth Trackers

What else could you do with the money?

One of the main arguments that comes up against paying off your mortgage early is that you should be investing and growing that money instead. And it’s a strong argument. You could be missing out on decades of market gains if you throw extra cash at your mortgage instead of, say, your retirement fund.

It could also be argued that once your mortgage is paid off, you’ll have more money to invest in stocks. But even if you’re able to reduce a 30-year mortgage to 15 years, you will still have lost 15 years of compound investment earnings. That’ll be close to impossible to make up.

Not only that, but investment returns can be wildly inconsistent. How would it be for you if you accumulated $100,000 in your stock portfolio over the past 10 years – instead of paying off your mortgage early – only to see an ugly bear market wipe out 50% of your portfolio?

And it’s not just long-term goals that could suffer if you pay off your mortgage early. You might also be neglecting some very worthwhile mid-term goals.

Do you have a vacation coming up that you want to save for? It might be worth it to you experientially to pause on the extra mortgage payments and instead save for this trip. You’re going to savor the memories more than you’re going to savor the few years you saved on your mortgage.

Or maybe you have a kid going to college. Putting that money into a 529 account could help set them up financially by offsetting student loans.

Check in with yourself about these goals. You can only do so much with your money and paying off your mortgage a few years early might not be the best way to use your extra cash.

If you’re already funding these goals, then it might be fine. You just need to make sure your short-, mid-, and long-term goals are covered.

Do the pros outweigh the cons?

Ultimately, you have to decide for yourself whether the pros and cons equal out. There are very solid arguments for both sides of the fence, but as Paula Pant is so fond of saying, personal finance is personal.

There’s no wrong answer here — unless you’re being reckless with your money. Some people feel better when they don’t owe the bank money. I’m one of those people. Others would rather invest and get returns. My brother is one of those people. There’s nothing wrong with either type of person, so long as you’re doing it in a responsible way.

There are several situations when paying off your mortgage earlier than anticipated is a good idea. For instance, if you’re trying to retire early. In this case, you’ll want as little debt as possible. It’ll reduce your monthly expenses, too. All the pros of paying off your mortgage early will help you on your journey to FIRE (financial independence, retire early).

Another reason would be if you’re planning on staying in your home for a long time and want to supercharge the equity in your house. Equity is important — it’s what you own and it’s going to grow in value as time passes. If you’re planning on staying in your home for a while, you may very well want to own it and watch what you own increase in value as soon as possible.

A huge reason why you wouldn’t pay off your mortgage early is if you’re going to move in less than seven years. It doesn’t make sense to put all this equity into your house to not see it grow over time as housing prices rise.

Another reason would be if you’re not sure you can commit to paying it off early. If you abandon the early payoff effort before you complete it, you will have even more money tied up in your home than you have now; this is sometimes referred to as “dead equity” since it has no return and produces no immediate benefit.

In both cases, it makes more sense to put your money into the market. You’re going to see better returns.

There are generally three ways to pay off your mortgage early:

1. Split your payments — One of the best ways to pay off your mortgage early is to split your monthly payments in half and pay every two weeks. While this doesn’t seem like a huge change, you’ll end up making a few extra mortgage payments a year this way — without seeing a huge difference to your budget.
2. Add to your payments — Another great way to pay your mortgage off early is to add a few extra hundred dollars with every payment. As we saw at the beginning of this article, that’s a great way to shave years off your mortgage.
3. Lump sum it — Finally, you can pay off lump sums of your mortgage at a time. Lump sums will help bring down the mortgage a jump at a time and can be good if you get a windfall or an inheritance. Just don’t use your emergency fund as that lump sum!

Paying off your mortgage early really comes down to your personal financial goals. Do you want to prioritize investing or ownership? Will you risk being cash-poor? Will you be hit with a penalty that negates the interest you’ve saved?

Ultimately, you have to ask yourself the question of why you want to pay down your mortgage early, assess what it’ll cost you in both the long term and short term, and work through the pros and cons yourself.

Featured image: Monster Ztudio/Shutterstock.com