How to Decide Whether to Pay Off the Mortgage Early
With home prices stagnant, paying off a mortgage early might seem like a smart way to reduce debt, but like always, one size doesn’t fit all. The strategy may not be ideal for your situation.
“With consumer resolving debt balances declining nationwide and home values flat, some homeowners are considering paying off their mortgages early,” says Kevin Gallegos, vice president of Freedom Debt Relief. “For people who are staying put in their home for some time, paying off a mortgage before the end of its term has benefits. Obviously, making extra payments eliminates the loan debt faster. This in turn dramatically lowers the total interest paid over the life of the mortgage,” says Gallegos.
Truth is though, not everyone gains from paying off the mortgage early. Here are a few things to think about to help you make up your mind.
Are all other needs under control? For anyone, paying off credit card debt and contributing the maximum to a retirement plan are goals that should beat out paying off the mortgage early. Those planning to retire soon might find it appealing to eliminate the mortgage. “It’s most important, in that situation, to be sure you will have enough cash to fund your retirement,” says Gallegos. Ask yourself: Can you afford to pay more each month? Do you have an emergency fund that could cover six months’ living expenses? If the answer is no, chillax on the idea of paying the mortgage early. Continue paying your regular monthly payment until you can answer yes.
Is a move coming up? If you might sell your house soon you would do better to put extra cash in a fund for a new home down payment. “The market is still a bit wobbly in most locales,” says Gallegos. “Lenders are demanding higher down payments than in recent years. If you plan to relocate soon, hang on to your cash for the move,” he adds.
Check for prepayment penalties. Most mortgage loans do not have a prepayment penalty. But those that do present heavy charges for paying the balance off early. Review the Truth in Lending disclosure to find out.
The earlier, the better. Making extra payments earlier in the life of the mortgage makes a bigger difference in the amount of interest the bank collects over the years.
Analyze the mortgage interest deduction. Homeowners who itemize deductions reap tax benefits from paying mortgage interest. Naturally, paying a smaller amount of interest results in a lower total itemized deduction amount. (To find the potential savings, multiply the mortgage interest paid by the applicable tax bracket.) The difference could be thousands of dollars annually, so plan accordingly.
What else could be done with the money? Find the rate of return for a paid-off mortgage with an online mortgage tax-deduction calculator. Then compare it to potential earnings on investments. Most people would fare better by investing the money instead of paying the loan, especially when considering the interest saved over time. Those who can pay the mortgage early might do well to do so and then invest what had been spent on monthly payments in a savings or retirement vehicle.
Lastly, says Gallegos, “Paying off a mortgage can be a great relief. On the other hand, with mortgage debt, you’re paying to own your own home, with beneficial tax deductions. Either option can be a good one. Consider our complete financial picture before choosing the right path to home ownership.”
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