If you own a home, you may wonder, “Should I spend extra each month to pay off my mortgage ahead of the regular schedule?”
By making extra payments, you can shorten the length of your loan and save on the total amount of interest that you’ll pay. While that seems like a great idea, there are costs to directing extra funds to paying down your mortgage. There are pros and cons to every option. So how do you decide what to do?
Saving on Interest
The most immediate and clear benefit of paying off your mortgage faster than scheduled is that you will pay less interest overall. Even a low interest rate can accumulate a lot of interest over the long term of a home loan. Cutting even a few years off a 30-year mortgage, through larger payments, extra payments, or lump sums, can save you tens of thousands of dollars.
For example, on a 30-year loan of $300,000 borrowed at 6% interest, paying an extra $200 a month means that you’ll pay off the loan nearly seven years early, saving around $91,000 in interest. That’s huge!
The Opportunity Cost of Paying Ahead
Accelerated payments might be a missed opportunity to invest funds elsewhere. From a purely numbers perspective, it makes sense to invest elsewhere if the other investment is earning more than you’re paying in interest on your mortgage.
In a simple example, if you have a 5% interest rate on your home loan, and you can earn 6% in another investment, the math says you should pay the minimum on your mortgage and prioritize the other investment.
Of course, it’s not quite that simple, because there can be additional considerations to add to the equation, such as whether you’re deducting the interest paid on your income taxes or whether the other investment income is taxable. Making those additional adjustments may mean that 1% difference between the mortgage and the investment can actually be more or less. Every situation is different.
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Guaranteed Return on Your Money
While other investments may offer higher returns than your interest rate, those returns may be less predictable. In contrast, paying down a home loan gives you a guaranteed value equal to your loan’s interest rate. That value is risk-free and not subject to market conditions.
While that value may not equal what you can earn in investments like the stock market, the certainty of saving that interest is a safe and predictable financial benefit. Even folks who can handle a relatively high level of investment risk probably want some lower-risk actions, and paying down a mortgage can provide a balance.
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The Impact of Inflation on Your Mortgage Payment
Keeping a fixed-rate mortgage can make even more sense when you consider how it works with relation to inflation. Whether we have high inflation or low inflation, general prices and wages rise over time. Your fixed-rate mortgage payment remains the same, effectively becoming cheaper over time. Paying it off early eliminates this hedge against inflation.
Cultural and Societal Beliefs
For starters, many people are taught that paying off a mortgage is an important and desirable financial milestone. For some, the idea of owning a home outright represents true financial freedom.
Of course, you’ll still need to pay for taxes, insurance, and upkeep on your home, but paying off your mortgage will eliminate that large monthly obligation.
Debt Free vs. Cash in the Bank
Some people are very comfortable having a home loan, and may feel better knowing that they have more cash in the bank or that they’re earning more money in other investments. Paying off your mortgage means that your money is tied up in an illiquid asset—your home equity. Unlike a savings account or investments, your home’s equity cannot always be quickly or easily converted back into cash.
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What’s Right for You?
The decision to pay off any loan early is very personal. You have to consider the math and the emotions. Keep in mind that this may be a decision you need to revisit over time, as your life changes. Paying more may make sense in one situation but not in another situation.
Like so many aspects of your financial life, the decision to pay more quickly may need to adjust as the rest of your financial plans change. It’s not a one and done deal!
Whether it's worth paying down your mortgage faster depends on your goals, thoughts about debt, and bigger financial picture. Understanding the advantages and disadvantages can help you make an informed, strategic decision about your money.
