We discussed tackling your mortgage in our post about new year’s resolutions for homeowners. When adding this to your list, you might look at two benefits: saving on interest rates and owning your home early.
These two reasons give added benefits, but early mortgage payoff still isn’t for everyone. As much as it offers new opportunities, it takes some of the old ones away.
So, how do you know if this is a workable goal for you (right now)? We’ve listed some pros and cons below to help you decide where you fall.
I | Penalties and Early Repayment of Your Mortgage
If you’re considering paying off your mortgage early, contact your lender. Ask about their prepayment penalty for early mortgage payoff and how much it’ll cost you. This price tag alone might have you shaking your head and striking it off your list.
Mortgage providers can’t always impose prepayment penalties on most mortgage loans. If your provider attaches a penalty, it can only last for the first three years. During that time, the penalty cap within years one and two is 2%. This number drops to 1% in year three.
Penalties may also apply if you sell or refinance before the specified period outlined by your lender.
If you haven’t yet applied for a mortgage, consider this a deal-breaker when settling on a provider. Find one with the best rate and no penalties for early mortgage payoff.
II | Advantages of Paying Off Your Mortgage in Advance
1. You’ll remove a significant financial burden from your life.
Eliminating your monthly mortgage payment will free up extra cash. It’s one of the top first perks when considering early payoffs.
The extra funds can go towards your retirement, your child’s college tuition, paying off student loans, or some other investment.
2. You’ll save thousands of dollars in interest.
Interest payments make up part of the total mortgage payment you make each month. The other percent is your principal. When you lower your principal, you end up paying less interest. We’re talking thousands of dollars saved in mortgage interest payments.
You can save on interest even without paying off the loan. A large lump sum can lower your loan balance and, by extension, the interest. On top of that, you’ll reduce your payment period and build your home’s equity.
When depositing extra payments, note you’re paying toward your principal balance, not the interest.
Once you’ve covered 20% of your total loan amount, you can cancel your private mortgage insurance (PMI), lowering your monthly payments further.
3. You’ll gain peace of mind owning your home outright (especially before retirement).
There is financial peace of mind in knowing you own your home. If you meet any future financial difficulties, especially close to your retirement, foreclosure from non-payment is a worry off your plate.
4. Gain access to your house’s equity for future investments.
If you’ve paid off your loan, or a large enough portion, you can access your home’s equity. Accessing your home’s equity means you can convert its value into cash if you’re ever in a bind. There are risks to cashing out as it adds another lien to your property and increases loan expenses.
Your home’s equity should be, in most cases, a backup emergency fund. It’s a cheaper alternative to an unsecured personal loan. All the same, be wise about making this decision.
Speak with a financial planner or advisor about whether leveraging your home’s equity is a wise choice. Besides using your equity for an emergency, you can explore another investment option with a higher rate of return.
III | Disadvantages of Paying Off Your Mortgage Early
1. No more tax deductions on interest payments.
As a homeowner, you can claim the amount you pay for the interest when filing your taxes and lower your taxable income. This tax deduction means you’ll get some of your money back. Once you pay off your loan, you’ll lose eligibility for this federal mortgage interest tax deduction.
2. The housing market is unpredictable.
High home equity and low mortgage rates may prompt you to pay off your mortgage early. But, if market prices fall drastically, your equity will too. This is a homeowner’s worst nightmare. A high percentage of your net worth becomes tied to the house if you pour all of your cash flow into early repayment.
If your home loses value faster than you expected, you may lose a significant amount of your investment. Some experts recommend investing in other areas like the stock market instead of hurrying repayment.
3. Your credit score may drop.
Thinking about your credit score dropping because you paid off a loan may seem strange. Usually, you’re penalized for non-repayment and other infractions. However, one factor calculated by credit companies is your credit mix.
Your credit mix refers to the credit types you have in your credit report. For instance, you may have a car loan, mortgage, and credit card. Removing one of these three, especially the mortgage, may decrease your score. Not by much, but it could be enough not to meet another lender’s preferences.
IV. Questions to Ask Before Paying Off Your Mortgage Early
Paying off your mortgage earlier might help you save money, but there are other things to consider before deciding.
1. Do you have other options besides paying off your mortgage early?
You can refinance your current mortgage if you want to cut your interest. Check out the refinance rates and speak with your mortgage lender about how much you stand to save going this route.
Refinancing doesn’t eliminate your mortgage but can lower your interest rate and monthly payment and grant you a shorter loan term. This option may be more favorable than sinking all your money into one venture.
You can also make an extra payment or two towards your principal payments each year.
2. What are your plans for the extra money?
Decide on your plans for the extra funds before paying off your mortgage in advance. Compare the financial options available: investments, savings, and retirement. Determine which of these will yield the highest returns in the long run.
Remember, once you pay down your mortgage, all your money becomes wrapped up in your house and a volatile housing market.
It’s a major financial decision and one you don’t have to make alone. Speak with a financial advisor for expert advice. Set out your long-term financial goals and take it from there.
3. Do you have any other debt?
When you organize your debts by interest rate, which is the highest? Is it your mortgage? Or perhaps a private student loan?
Apply the general rule of thumb of paying off high-interest debts first. You’d benefit more by paying these off before your lower interest debts.
Debt repayment is a balancing act. You don’t want to pay too much on one and risk defaulting and wracking up late penalties for another.
4. How are your savings and plans for retirement?
Check your current cash reserves. Do you have enough for emergency expenses, regular savings, and retirement? Planning for the future in your golden earning years is essential. This means setting aside money for your retirement.
Diverting those funds into your mortgage instead of your tax-free retirement contributions can cost you in the long run. Not only will you miss out on accumulating interest on your retirement fund, but you’d also be missing out on tax deductions.
Conclusion
Relieving the debt burden is a personal finance goal most Americans are tackling. Paying off the mortgage first is often an attractive move because of the low-interest rate, the potential savings of clearing this debt once and for all, and the feeling of owning one’s home outright.
The downsides, however, can outweigh these expected benefits. There might be other high-yield investments that would be better worth your time. The tax deductions you’re currently receiving may play a more prominent role in your budget than you realized. Then there are the other debts on your record. Higher-interest debt rank higher in priority for repayment.
Whatever you decide depends on your financial standing. Review the pros and cons and choose the path suitable for you.
