Is it a good idea to pay off your mortgage early?

While paying off your mortgage early sounds like a great financial decision, it is not always the case. There are times when it makes sense to put your money elsewhere instead of adding extra cash to your mortgage payments. Due to the nature of your mortgage, it could also cost you more money to pay it off early. For example, some mortgages come with an early payment fee known as a pre-payment penalty. This fee might eat up most of the savings you were trying to keep. In this article, we will discuss the top reasons why paying off your mortgage fast might not be a great financial choice.

We will also explore the potential benefits of paying off your house early. These benefits will include owning your home outright which takes away the risk of foreclosure, lowering interest charges and increasing your savings, and not having to worry about mandatory monthly mortgage payments.

Without further ado, let’s get started.

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When does it make sense to pay off your mortgage early?

If you have all the needed cash and have nothing else to do with it, it makes sense to add that extra cash toward your mortgage payment. By paying your mortgage early, you will reduce the interest charges you pay overall. This trick can save you thousands of dollars by the time your house is fully paid off.

As long as you have an emergency fund, do not keep more money than necessary in your savings account. It would not make sense to keep your money in a savings account where you earn 0.05% APY when the same bank is charging you 6% interest on your mortgage. What you can do is use that money and pay off your mortgage.

If you have a mortgage that comes with a higher interest rate, a smart way to get out of it is to refinance your mortgage to a lower interest rate instead of working two to three jobs to pay it off.

Why is paying off your mortgage not smart?

Paying off your mortgage early is typically not a wise decision because it may not actually save you money in the long run. Mortgages typically have a lower interest rate than other types of loans and investments. So, if you pay off your mortgage early, you may be foregoing the opportunity to earn higher returns on your money. In addition, paying off your mortgage early may decrease the number of tax deductions you are eligible for, as the interest payments on your mortgage are typically tax-deductible.

The following are the reasons why paying off your house early might not be a good idea.

1. You miss out on potential investments

Although it sounds like a great financial choice to pay off your mortgage early, you could benefit more if you put your money elsewhere. For example, throwing every dollar you make toward mortgage payments robs you of the chance to invest money, save for retirement, and build wealth. Investing works best when you invest for the long term due to compounding interest. You cannot save and invest for retirement when all your money is used to cover your mortgage.

For example, if you have a low-interest rate mortgage, it will not make sense to pay off your house faster. Instead of adding extra money toward your mortgage, invest that money in high-yield investments and use some of your return on investment to cover your mortgage. If for example, your loan comes with 2.5% interest, you can invest the extra money you have in investments with like 7-12% interest. In this case, you will be winning. You are paying 2.5% interest to earn 12% interest. That is how you think like a bank and take control of your finances.

2. You are avoiding the highest-interest debts

Juggling through multiple debts can be challenging. A big mistake many people make is to focus their attention on their mortgage because it has a higher balance. What they forget is that mortgages usually come with lower interest rates compared to revolving credit such as credit cards and personal loans.

Paying off your mortgage early is not smart when you have high-interest loans knocking on your door. Instead of putting extra cash toward your mortgage monthly payments, use that cash to pay off higher-interest loans. If you need guidance on how to pay off your debt, refer to the following related articles to pay off debt.

3. It is not smart to pay off your mortgage early when it comes with a pre-payment penalty

Paying off your mortgage early is not a good idea when it comes with a prepayment penalty. The prepayment penalty is a fee that some mortgage providers charge when you pay your balance in full or a portion of it early. These payments are essential to make sure that borrowers keep the mortgage longer which helps banks to collect interest charges for a very long time.

In case your mortgage comes with a prepayment penalty, it might be a bad idea to pay it off fast. Of course, if you have cash, it might be financially viable to pay off your mortgage balance in full and be done with it. But, if you have a small payment and want to use it toward your mortgage payments, ask your lender before you submit it.

Mortgage tip. Before you pick your mortgage lender, make sure that your mortgage does not come with a prepayment penalty. This will allow you to pay off your house as quickly as you want without being penalized for it. In addition, make sure that the extra payment you make goes towards your principal. Lowering your principal means that the next interest charges will be much smaller since they are calculated based on your mortgage balance.

4. Paying off your mortgage early is not smart when you don’t have an emergency fund

Taking care of your finances and planning for emergencies is one of the most important financial decisions you will make. Most people never think about emergencies until they experience a real one.

One simple emergency can turn your whole life upside down and make it impossible to recover financially. For example, a simple car accident can result in a costly medical bill. Or a simple economic downturn can leave you with no job for months or years. Instead of paying off your mortgage early, use that extra cash to build an emergency fund first. Once your emergency fund is complete then allocate your extra cash toward your mortgage monthly payments.

5. You miss out on tax deductions when you pay off your mortgage early

Paying off your mortgage early can increase your taxes in several ways. The interest you would have paid on the mortgage will become taxable income if your mortgage is paid off early. According to MERRIMACK Tax Associates, when your house is fully paid off you automatically lose the deduction you would have gotten on your mortgage interest payments.

Paying off the mortgage early could potentially increase your taxable income. The fact that you will not be paying interest charges on your monthly, your tax liability goes higher.

Pros of paying off your house early

You will save money on interest charges. By default, the longer you keep the mortgage, the more money you pay in interest charges. So, when you pay your mortgage faster, you end up making fewer payments. This leads to paying less money in interest charges and you can easily save tens of thousands of dollars in interest by paying extra cash each month.

You get to own the house faster, lower the risk of default, and have peace of mind. Your house belongs to the bank until you fully pay it off. If you default on your mortgage, the bank can foreclose it and sell it at auction. Paying off your mortgage early gives you the right to fully own the house soon enough which minimizes the risk of losing it during a financial downturn. This in the end gives you peace of mind and a sense of security.

You get to allocate your money elsewhere. After paying off your mortgage, the money you are not using to pay off your mortgage (monthly payments) can be used to fulfill other financial obligations. For example, you can use the money to pay off other debts you have such as credit card debt, personal loans, student loans, or car loans. You can also use your money to buy other forms of investment property such as rental property, stocks, REITs, Bonds, land, stocks, Funds, etc. If want to learn more about investing and where to invest money, read this article for more details.

Cons of paying off your house early

You could end up with a mortgage payment penalty. Many mortgage providers apply a pre-payment penalty on your loan when you pay all or a portion of the mortgage early. Unless you have a mortgage that does not come with this fee, you might end up with hefty fees if you pay off your mortgage early.

Paying off your mortgage early could hurt your credit score. Your credit score is a number that ranges from 300 to 850. One of the factors that affect your credit score is your credit mix which is a combination of different credit accounts such as revolving and installment credits. Your credit mix affects 10% of your FICO score calculation. So, paying off your mortgage early might affect your credit mix which in turn will lower your credit score.

When you pay off your mortgage early, you lose tax deduction perks. Interest you pay on your mortgage monthly payments can be claimed on your tax returns. This trick can help you lower your tax liability and save money. After you have paid off your mortgage, you will no longer have these tax benefits.

You lose potential returns on other investments by keeping too much equity in the house. Paying off the house faster means that you will have thousands of dollars in equity sitting in the house earning you nothing. The house will only return something from appreciation if you bought it at the right time. There are investment alternatives that guarantee higher ROIs compared to keeping most of your money tied into your home.

The bottom line

Although paying off your house fast might not be a good idea, there are times when it makes sense to pay off the house and be done with it. It all depends on your financial situation, the nature of your mortgage, and your future goals. For example, keeping the mortgage longer gives you tax benefits. But why would you worry about tax deductions while paying thousands of dollars in interest charges on the mortgage?

If your mortgage comes with a prepayment penalty, paying your mortgage early could also mean paying extra fees that could have been avoided. You will also miss out on potential investments with higher returns by keeping all your money locked in home equity.

It is also important to note that when you pay off the house, you minimize the potential risk of losing in foreclosure. So, paying off your mortgage early or holding it longer is a matter of balancing the risk and rewards while factoring in your financial well-being.