Top blog articles
Buying your very own house is one of the most significant milestones in life. However, it can also be an overwhelming phase of life. There’s always the thought of a looming mortgage loan at the back of your mind. You’d want to pay it off as soon as possible for your peace of mind. But, is that a smart move? This blog will help you understand why you shouldn’t pay off your house early.
Before you use your savings or inheritance to pay off your mortgage, it’s important to determine whether such a step actually makes financial sense or not.
Often, the money you save by paying off your mortgage early may not be more than what you’d earn with a better investment elsewhere. That is to say, instead of using all your funds to pay back your home mortgage early, you may want to put them to better use – for a higher return.
Having said that, the actual answer to why you shouldn’t pay off your house early also depends on what your priorities are – being debt-free and getting rid of a huge monthly expense or a potentially better investment.
If you’re looking for better utilization of your hard-earned funds, read on to know why you shouldn’t pay off your house early.
Is paying off the mortgage early possible?
Yes, it’s possible – depending on the terms and conditions set by your loan lender. That’s why if you’re thinking about paying off your mortgage early, it’s best to talk to your lender first. Keep in mind that prepayment penalties may apply depending on the terms of your loan. However, under the Dodd-Frank Act, many mortgage lenders are generally forbidden from imposing prepayment penalties on house loans unless they are exempted from the rule.
How much is a prepayment penalty, on average?
Only the first three years are subject to a prepayment penalty. In years one and two, it’s capped at 2%, and in year three, it’s capped at 1%. For example, if your loan debt is $295,000 in year two and you pay it off, the lender could charge you a prepayment penalty of up to $5,900.
Who benefits most from an early mortgage pay-off?
Paying off a mortgage early often benefits homeowners who’re nearing retirement or those planning to stay in their homes for an extended period of time. Furthermore, if you’re someone who’s stressed at the thought of owing money, paying off a mortgage early can bring you much-needed peace of mind.
You also need to consider the prepayment penalty and the potential tax consequences before making the decision. The bottom line is that you have to see if the benefits of paying off your house early outweigh the cons.
What are the factors to consider before paying off the mortgage early?
Ask yourself some pertinent questions before paying off your debt. The answers will make better sense if they are specific to your financial situation.
- Is it more sensible to pay off your mortgage or invest it wisely somewhere else?
While no one can give you a guarantee on any type of investment, it’s almost always better to invest in other lucrative places than in your mortgage. For example, it may be more profitable to take the mortgage money and leverage it into buying a property that shows the potential to give higher long-term returns.
Or, you could invest in the stock market and get an annualized return for S&P 500. It all boils down to home much risk you’re willing to take.
- Will it deplete your fund liquidity?
Another reason why you shouldn’t pay off your house early is that since real estate is considered a non-liquid asset, you risk depleting your liquidity by using up all your funds toward your mortgage pay-off.
This will not leave enough for an emergency fund or money to buy assets or liquid cash such as stocks, mutual funds, U.S. Treasuries, bonds, and marketable securities.
- How will you use the money?
It depends on how you manage your finances. If you’re going to anyway blow up the extra cash you have, then it’s better that you put it into your house – thinking of it as a forced financial planner. If you’re using the funds elsewhere such as paying off high-interest debt like a credit card debt or a higher interest personal loan, it will make more sense to you. Or, you could use the lump sum to fund your child’s education.
- How important is peace of mind to you?
If you want to own your home free and clear, without any tension of paying your monthly loan payments, then maybe you’re better off ending your mortgage debt. Especially if you’re living on a fixed income.
- Will you be applying for another loan?
Once you pay off your mortgage, you may be able to borrow against the equity in your home. For example, in the case of a home equity loan or a home equity line of credit (HELOC). Moreover, your home becomes a source of emergency income. You may even make plans for home improvement projects or other financial goals.
Pros and cons of paying off your mortgage early
- Gives you mental relief and peace of mind.
- Ends your monthly mortgage payments.
- Makes extra funds available for use at the time of retirement.
- Potentially saves money in mortgage interest.
- Gets you a predictable mortgage rate of return (same as the interest rate on the balance amount you’re paying off).
- Makes it possible to tap into your home equity if you need money in the future.
- Ties up fund liquidity and your net worth in the house.
- You will not be eligible for the federal mortgage interest tax deduction.
- You’ll miss out on the chance of investing in real estate, the stock market, etc. for increasing your earnings.
- It may not get you a good return if the real estate market drops and you have to sell quickly.
- You may have to pay a prepayment penalty.
How do you pay off your mortgage early?
If paying off your mortgage early makes financial sense for you, here are some strategies to go about it:
- Make extra mortgage payments such as biweekly payments to reduce the home loan term and get ahead on your mortgage.
- Make additional mortgage payments each month or year on top of what you already pay. Ensure that the extra money is allocated to the principal loan amount.
- Refinance to a mortgage type with a shorter term. For example, you could switch from a 30-year mortgage to a 15-year mortgage. Of course, it would mean a higher monthly payment.
Read more: What is home equity conversion mortgage
Before you use up a chunk of your saving to pay off your mortgage early, consider the advantages as well as disadvantages of doing so. Know what will work best for your financial situation. And, whether it will help you reach your short- and long-term financial planning, or not.