The quick answer to the question of whether you should pay off your mortgage early is, it depends. And ultimately, that decision is best made by you with the help of a trusted financial advisor who understands your financial situation. But to best equip yourself for that conversation, here are a few things you should know about paying off your mortgage early.
You should have some cash cushion in the bank
First, you’ll want to make sure you have some cushion in the bank. “You [should] have enough cash reserves to cover all expenses for at least two years after paying off the mortgage,” says Karen Kostiw, licensed real estate salesperson at Warburg Realty. “You do not want to be put into a position of paying off your mortgage, then losing your job and incurring an unexpected medical expense, for example.” There’s no point in draining your reserves to pay down a mortgage if it leaves you dangerously low on cash.
When thinking about cash reserves, homeowners should also consider their liquid assets—and houses don’t fall into this category. Alex Lavrenov, also of Warburg Realty, points out: “The main issue here is not with the concept of mortgage or pre-payment, but rather that real estate and real property is not a liquid asset, meaning it is much harder to cash out and the value can change drastically over time (in both directions). The cost and process of selling your home, with a mortgage or not, is usually more of a timely and costly process than withdrawing cash from the bank.”
This kind of situation can be especially precarious if you need to sell your home in a pinch—by paying off your mortgage early and committing to the full value of your home, you risk losing money to depreciation.
You might face a prepayment penalty
Next, check should check to see if your mortgage includes a prepayment penalty. This is a fee that your mortgage lender may charge you if you pay off your mortgage early (this is because they were counting on those 15–30 years of interest payments).
“Prepayment penalties for mortgage loans are not common,” says Daniel Cohen, consumer finance expert and managing editor of Bills.com. “You won’t find them on fixed-rate mortgages. There are penalties for some adjustable rate mortgages (ARMs), however. Federal law requires prepayment penalties to be disclosed to you by the lender before you’re charged for any non-refundable fee. There is also a requirement that a homeowner must sign a clear disclosure at the closing of the loan.”
The main issue here is not with the concept of mortgage or pre-payment, but rather that real estate and real property is not a liquid asset.”
If you do have a prepayment clause, you might want to reconsider prepayment. Penalties will vary based on the terms of your loan, but a common fee structure is 80% of six months’ interest. If that sum is lower than the interest you would save by paying off your mortgage early, then you might be alright.
Your money may better invested other places, especially if you have a low interest rate
Depending on your interest rate, the money you might spend prepaying your mortgage might be better invested elsewhere. Larger monthly payments will mean less money to put toward other monthly expenses.
According to Randall Yates at The Lenders Network, “[For] homeowners that have a fixed-rate mortgage with a low interest rate below 5%, [this] isn’t necessarily the best use of capital. If you can invest the extra money into a mutual fund or EFT and earn around 10% annually, you’ll come out better than if you spent that money on paying down your mortgage.”
Yates also cautions homeowners to consider the tax deductions that come with having a mortgage. “Interest paid on a mortgage loan is tax deductible, which in some cases can be significant. If you have a low rate and you’re deducting interest payments on your taxes, it’s a much better use to put that money into a high-interest-bearing account.”
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