Most people who have a mortgage question whether they are better off paying it down as soon as possible or putting their hard-earned money into other investments. This is an age-old question without a clear answer. However, once you analyze the pros and cons of paying off your mortgage early, the decision becomes much easier.
Why It Makes Sense to pay off a Mortgage Early: Reduce the Interest Paid
Wouldn’t it be nice to dramatically reduce the amount of interest you pay on your mortgage? Think of all the other ways you could use the cash. You could sock the savings away for retirement, your child’s education, a vacation or a new car. Pay off your mortgage early, add up the savings and you just might find you have an extra couple thousand dollars or more to spend on whatever your heart desires.
Pay Early to Free up Cash Flow
Paying a mortgage early frees up that much more cash for monthly expenses. This cash flow decreases the financial strain on your family, provides you with more money to invest and provides an invaluable peace of mind. There is a good chance the money you invest might produce quite the lofty return that otherwise would not have been possible had you kept paying your minimum monthly mortgage payment month after month.
Pay Early to Cancel the Private Mortgage Insurance
It is possible to save a good chunk of money by paying a lump sum on the loan balance yet some homeowners are unaware of how this is possible. Here’s the scoop: when you reach 20 percent equity in your property, you can cancel the private mortgage insurance. Private mortgage insurance typically costs the average homeowner between half a percent and five percent of the initial loan balance. Though the savings from eliminating private mortgage insurance might not be substantial at first, the money will add up to a meaningful amount in due time.
Why It Does not Make Sense to pay a Mortgage Early: Poor use of Cash Flow
Some argue using cash to pay down a mortgage early is a bad idea as there are better uses for the money. Think of all the ways you could use the cash to make even more money rather than pay down your mortgage early. You could use your cash to invest in stocks, mutual funds or your own business. Furthermore, it makes sense to keep a considerable amount of money in savings to cover emergency expenses.
About That Prepayment Fee…
Though it seems egregiously unfair, certain home loan lenders might also charge borrowers a prepayment fee for paying down the loan early. Take a close look at your home loan mortgage agreement and the lender’s policy on prepayment before making early payments.
Consider the Tax Consequences
For some, paying down a mortgage early does not make sense as deducting mortgage interest is an essential part of their overarching tax strategy. If you can no longer itemize deductions after paying down your mortgage as there is no longer any mortgage interest, you will likely end up paying more in taxes than originally anticipated.
Consider Your Plans for the Future
If you plan on selling the home in the next five years, it does not make sense to pay down the mortgage early. However, if you plan on staying in the house for a decade or longer, it is sensible to pay down the mortgage sooner than later so you are not stuck with interest payments tacked onto the loan balance year after year.