Is paying off the mortgage early sound financial decision? Real estate agents, bankers, financial advisers, and money managers have their opinion. There is no one size fits all, and the decision to contribute a little extra on top of your monthly payment should come after some serious consideration.
Do you have an emergency fund in place?
Without one that covers 3 to 6 months of monthly expenses, you shouldn’t even be thinking of making those contributions. Instead, make savings a priority. How much you should put away largely depends on your age, job situation, and household income. If you have an unstable position (seasonal job, freelancing, etc.), more is better. However, if your job seems secure, plus you live in a two incomes household, you might be okay with having three months’ worth of savings.
How much do you owe outside of your mortgage?
When you are drowning in credit card, student or personal loan debt, adding to your principal doesn’t make sense! If your mortgage interest rate is 4%, but your credit card charges you 22% you know what to do! Pay off your credit card and everything else you owe first! Here are some ideas on how to do that.
You have no other debts. What’s next?
This is the situation that brings confusion. But it is a nice place to be! Assuming you are contributing at least 15% of your income into retirement accounts and still have room for increased mortgage payments, what should you do? Let the house loan run its course, and invest the extra cash flow they have? Or should you put every spare cent towards the principal, be done with it in record time, and invest afterward? Let’s examine it closer.
The biggest pros for paying it faster
When you decide to add an extra amount of money each month towards your principal, two major things happen: you save tons of money in interest and the life of the loan becomes much shorter. To find out how much time you could save, use this mortgage calculator.
For example, if you are buying a house for $100,000, with a 20% downpayment, a 3.5% interest rate, 30-year fixed, your monthly payment will be around $360, not including property taxes and monthly insurance. Adding just 100 dollars every month not only would save you $17,455.47 in interest, but you would pay off the mortgage in 20 years and 3 months. Almost 10 years ahead of the schedule!
Once you are clear of any mortgage payments, your budget needs a major adjustment to accommodate increased cashflow. I recommend using a portion of it to enjoy, after all, you deserve it! The other portion should be invested, either in stocks, bonds, or simple CD’s. Or if you want, you could save it and perhaps purchase a rental unit. After all, the real estate is the force behind building the wealth in this country!
Unfortunately, the investment community is predominantly focused on the financial benefits of these decisions, leaving the emotional part of it on the side. But the moment you pay the last of what you owe and become DEBT FREE should have a tremendous impact on your well being! Just the fact that you are no slave to the lender anymore gives you a new sense of freedom. For many people, that’s the feeling they forgot since they carried on various loans for the past 30 or more years of their lives!
When was the last time you didn’t have to worry about any payments?
Cons for paying off the mortgage early
The biggest reason why many people decide to carry on the loan is the low-interest rate they got on the mortgage. When you pay 4% or less in interest and invest the extra money that can yield a 10% return, wouldn’t that be a better return on your investment?
Another huge benefit is the possibility to deduct mortgage interest when filing for taxes. The 2017 Tax Cuts and Job Act law allows homeowners to deduct the interest they pay for the year for the first $750,000 of the mortgage for the qualified residence. Previously, that cap was $1 million. The Government wants to encourage homeownership, and this is one of the ways. Deducting the mortgage interest from taxable income, you lower your tax bill, which can put you in a different tax bracket.
At the end of the day
I believe that the decision for paying your mortgage early for you might not be the right one for you, as it is for me. In many cases, pen and paper might be a good place to start evaluating the options you have. Also, don’t be afraid to ask for help. A good financial advisor can do wonders for your financial life!