The Pros and Cons of Pre-Paying a Mortgage

You should know right up front that while my wife and I have a mortgage, one of our top financial goals is to have it paid off by the time our kids enter college (some seven or eight years away). To get there, we’ll have to invest a significant portion of our income towards pre-paying the mortgage, but the thought of owning our home outright is a huge motivator.

So I’m a huge proponent of truly owning one’s home mortgage-free.

That said, here are some pros and cons of paying off one’s mortgage before the terms of  your loan are satisfied (the usual 15 or 30-year mortgage):

Pros:

Most personal finance experts recommend owning your home mortgage-free before, or soon after, your retirement. The amount of money you’ll need in retirement goes down considerably as a result since you won’t have to pony up hundreds or thousands of dollars each month.

In addition, by paying off your house early, you save thousands of dollars in interest over the life of the loan. Take a $100K loan at 8 percent interest over 30 years: you’ll end up paying a bit more than $264K for the $100K loan. Pay the loan off in 15 years and your cost declines to $172K, a savings of $92K.

Many people claim the tax deduction is a great reason to carry a mortgage. Personally, I never really understood that. My wife and I look at it this way: why would we want to pay someone $1 in interest in order to receive 28 cents in a tax-write off?  (If we pay $10K in mortgage interest in a year and we’re in the 28 percent tax bracket, we may deduct $2,800 from our taxes.)

Plus, as we pay off the mortgage, more and more of our payments go toward the principal, thus lowering the amount we pay in interest and thus lowering the amount of our tax deduction each year.

Cons:

Using extra cash each month to pay more on your home loan means you can’t use that money for other, important things. Things such as:

Also, you’d more than likely earn a better rate of return on your money if you invest it in mutual funds or the stock market rather than in pre-paying your mortgage.

Take the example of a homeowner at year five of a 30-year $200K loan at 6 percent who takes $1,000 she normally would have saved and instead pays it toward her mortgage. This homeowner adds $1,000 in equity to her home and saves $3,400 in interest. However, had she placed that grand in an investment vehicle that earned her an average of 8 percent over the next 25 years, her $1,000 would have grown to $6,800.

In addition, if she places that $1,000 in a tax-deferred savings vehicle such as a traditional IRA or 401(k), she’ll reduce her tax liability for that year.

Regardless of your personal feelings toward pre-paying your mortgage, you may want to consult with a tax advisor/investment advisor to determine if pre-payment is a good course of action for your situation. But a word of caution: don’t allow them to persuade you to keep a mortgage around so they can sell you a hot “investment.” The future financial security of your family may be at stake, and that is far more important than the chance to strike it big.

Comments

  1. Good article – I would like to point out that in the “Cons” section, you have pointed out areas which money should be going into before you would even consider paying your mortgage early.

    An emergency fund and paying off credit cards of course comes before the prepaid mortgage. Also, the subject of saving in a 401(k) or IRA is near & dear to my heart. One of the biggest problems with the current
    401(k) arrangement is that most people don’t know enough about it and don’t save enough for it to be an effective retirement plan. This is one of the topics I point out in my book, “Help! My 401(k) Has Fallen – And Must Get Up!” This is written to help ordinary employees get more from their 401(k) savings – so that when retirement comes, it can be a good source of income.

    For more information on the book or to get my FREE report, “The 5 Biggest Problems With 401(k) – And How To Fix Them”, visit my website.

  2. For us, paying down the mortgage is a mental things as well as a financial one. I don’t feel like the house is ‘ours’ until we have it free and clear. I’d love to pay the mortgage down even faster, but we’re busy building the emergency fund, etc. at the same time.

  3. I too am trying to pay off my mortgage as quickly as possible. I couldn’t agree more with the comment about how your mortgage is some great tax deduction. I threw away almost 10k in mortgage interest last year. How is that a good idea if I get 1/3rd back? Most people would call that a really bad investment. Sure, if you don’t have a choice and you have to carry a mortgage, it is a benefit to get a tax break. But keeping a mortgage for the sake of the tax break is crazy.

    Also, I am not too sure that I would get a better rate of return on mutual funds these days. I know that long-term, stocks have outperformed most other investment vehicles. However, so much has gone wrong in the financial markets and such lately that I don’t trust anything right now. I do know that if I own my house, nobody can take it away from me and at least I will always have a place to live. That means more to me than a few extra percentage points on my investment returns.

    Great post!
    Kris http://www.everydaytipsandthoughts.com

    • @ FD and Kris: I’ll just chime in to say that I would agree. When someone even mentions the tax breaks that come from mortgage interest, I just stop listening.

      I “only” had $9k in mortgage interest in 2009. Sad thing is… even with all of my other deductions, I was barely surpassed the “standard deduction” number. My overage was approx. $2k, which translates to about $500 in tax savings.

      So really, I paid $9k in mortgage interest in order to save $500. o.O

      • @Anthony: Excellent point about factoring in the standard deduction. Another way to look at it is if you were mortgage debt free, you still get $11k in a standard deduction, so it’s not like you are going from deducting $11k to $0k, as is often implied by those on the other side of the argument.

        • Can you elaborate on the standard deduction of $11k. We are aggressively working on paying off our mortgage and have approximately 3.5 years left. Once it is paid off, it has been a concern that we will not have a mortgage interest deduction anymore.

          • Kevin,

            When filing your tax return, you have the option to take the greater of either the standard deduction (11,400 in 2009 for married filing jointly) or itemizing your deductions (where mortgage interest comes into play). If you don’t have enough qualified expenses to itemize, you can claim the standard deduction. Even with my mortgage interest, I almost don’t have enough expenses to make itemizing worthwhile. If legislation is introduced to allow taxpayers to continue to deduct their property taxes without itemizing, I will likely be better off claiming the standard deduction next year.

  4. Is it just my computer or is some of the article on the right side cut off? Even the comments section is cut off.

  5. I appreciate both sides of the article as presented. BUT…..paying off your mortgaged is a guaranteed return. We follow Dave Ramseys Baby Steps, and I recommend them to anyone who will listen because they are so simple to follow.
    The article mentioned in the Cons section about not being able to pay off the mortgage early and perhaps save as much as you like for retirement or college. The Baby Steps gives highest priority to Retirement savings, then college savings, and then after you are contributing to those two, start paying off the home early.
    So easy to follow and it works. Three years ago my wife and I had $36,000 in debt. Now we are debt free with a fully funded emergency fund, are contributing 15% and 24% to our retirement accounts, saving $200 a month for our 9 month old daughters college fund, and paying a minimum of an extra principal payment a month.
    THANKS DAVE RAMSEY!

    • Paying off the mortgage is NOT a guaranteed return because of the uncertainty of future residential real estate prices.

      In this market you are risking a decline in principal (maybe your next door neighbor goes into foreclosure).

      Plus any future gains in residential real estate are unlikely to exceed the rate of inflation.

      It is of course your personal choice to invest in a relatively illiquid asset (your personal home) but don’t think for a moment it is as riskless as depositing that money into a FDIC-insured bank account.

  6. Each month I tick off about $2,000 off of my mortgage balance. At this point the interest we pay is negligible. The house will be ours in a little over two years. I can’t wait!….If your home is paid off, a lot can go wrong in your life, but you have a place to live and don’t have to worry about putting out a large sum each month for housing. I remember my grandparents. They had little to no money to live on, but they did not have a house payment/rental payment, so theirs was a comfortable existance with very little worry. My mom worked very hard to pay off her home early and did so, despite my dad’s complaints. He died young and if my mom didn’t pay off the house, she would have had to have worked through her 70′s in order to keep up the house payment and get the mortgage paid off. Instead, she has had a number of “leisure years” where she doesn’t have to scrimp and worry. Paying off the house is one of the best things a person/family can do, in my opinion.

    • Yes, but a lot depends on how much the house is worth and what town you live in–that’s right, I’m talking about property taxes.

      For those young couples who buy a $400,000 home on the east coast in a middle to expensive town, even if they pay off the mortgage by age 40, they will still have $400k times up to 4% property taxes to pay per year, which works out to ($400,000 * 4% )/12 = $1,333/month, guaranteed to be there for life, including retirement years. Ouch. Doesn’t feel so much like owning the home…

      Your grandparents and mother could only do what they did because they bought not such an expensive home in not such a high-property-tax town, and therefore their property taxes worked out to probably something like ($50,000 * 2%) / 12 = $83/month!

      • Yes, property taxes are a consideration but I would think if you are reading these types of blogs you are probably a frugal person and don’t owe a “house-payment’s worth” of property taxes each month! Hopefully a person is smart enough to figure in property taxes BEFORE you buy the house…but then again…..

        Sheesh…according to your tone there is no winning, so why even bother?!?! (oops, unless you are my parents and grandparents and live in shacks) I tend to take a more positive spin on it and prefer to be fiscally responsible on a personal level and buy what I can afford, pay it off early and then concentrate on other things. BTW, we live in Southern California, so it isn’t all that cheap, but if you are smart about it, buy when it is cheap ($400,000 isn’t cheap), you can do it.

      • CM, I am not sure where you got your numbers from but I live on the east coast and my property is valued at $375,000 by county. I pay less than $3,000 in property taxes per year. Use correct numbers please.

        • CM – I agree with Joanne.

          My taxes are $788/yr, or $67/month. Home valued at $200,000 which is more than median for our area. In town with all the city amenities.
          And 10 minutes from the Ocean, with a mountain view, etc.

          Add $788 to $386 for insurance, and that’s $1164/yr… or $97/month. That’s pretty darned cheap “owning” in my book :)

        • A note on property taxes are that they vary WIDELY by county/city/school district/utility district/community college district/etc. My house is assessed at 121,000 and I pay $2500 per year in property taxes (I live in a very affordable Midwest town.)

          The numbers posted by CM are likely accurate for his area. Another item to keep in mind, however, is CM’s area may be heavily funded by property taxes with considerably lower sales and income tax rates. Or maybe he lives in an area with high rates on all three. Talk about a trifecta.

  7. There is one reason to not pay off early and that is if you suspect that you will be moving in a few years. If that’s the case, you will likely be entering into another mortgage anyway. If you absolutely believe that you will remain in your house for the l-o-n-g term, then it seems to make a lot more sense.

    As for the tax deduction, the interest deduction can be particularly advantageous if you’re on the verge of moving up to that next higher tax bracket. The deduction helps when it is lumped in w/child tax credits, other itemized deductions, w/deferred comp plans, HSA’s and FSA’s, and anything else that can effectively insulate you from too much realized capital gain on April 15.

    • I, personally, would have to disagree with your first comment. Keep in mind that I am on the “pre-pay your mortgage” side of the fence.

      If we accept all of the other pros and cons of pre-paying, whether you will move or not is irrelevant. Why? Because pre-paying also means equity-building. And that equity goes directly into your next mortgage. I would rather have some equity (via pre-paying) than have zero equity… especially when/if I enter into a new mortgage.

      • Hi, Anthony–

        Of course, equity is equity, but for those who are young and early in their careers, they might not yet be well-enough prepared for life’s curve balls (6 mos. of EFunds). Once that money’s put toward the mortgage, it’s gone. Some would rather put extra funds in savings and securities since returns have a good chance of surpassing today’s low mortgage rates, esp. if they will have a long time horizon.

        Of course, we’d all like to do it all, but sometimes it’s just not possible, particularly for those who are just starting out.

        • Oh, and if you don’t have 6 months of emergency savings (and probably all consumer debt paid off) you probably shouldn’t be paying early on your mortgage.

    • Holly, I’m going to have to chime in a little bit. First, I think if you move, it’s ok to still own your house free and clear. Maybe you won’t have to take out another mortgage, or maybe you’ll just get a tiny one. But either way, I don’t see how moving or not moving really plays in.

      And your comment about interest brackets doesn’t really make sense. You do realize that once you move into a higher bracket, only the MONEY in the higher bracket is taxed at that rate. You aren’t suddenly taxed at 25% for all of your money, for instance. It’s just the money that exceeds the tax rate below it.

      • Yes, I understand marginal tax rates. For instance we would be in the 28% tax bracket, but we fall into the 25% since we contribute 10% gross to a deferred compensation plan and have itemized for years, which it where I am including the mortgage interest deduction benefit. This helps to avoid having my (small in comparison to my husband’s) earnings being taxed at the higher tax bracket of 28%.

        My point about selling the house is that if, in the next few years, we see growth in the market, you will likely make gains on a house with just an increase in market value. No need to tie up extra funds in paying down a mortgage…I’d rather put it in a fund or other growth investment and take advantage of the mortgage interest deduction. If you do move, you may decide renting is where it’s at and no longer have the deduction.

  8. After reading this, I immediately decided to write down my major financial priorities. I am only 23, so (god-willing) I won’t have children for awhile. My priorities currently are:

    Max out my HSA (done for the current year)
    Max out my Roth IRA (will do on May 1 – doubles as my emergency fund)
    Pay an extra $5000/year to my mortgage (sets me up for payoff in 12 years)
    Max out my 401k

    This doesn’t take into account travel goals, home improvement, etc, but I save for those items by scrimping my shopping, food and other budgets.

    It’s very encouraging for me to write out my goals and plan for exactly how I will meet them. Of course, life happens and the plan gets skewed, but at least I have one to modify rather than flying by the seat of my pants.

    • @Melissa: Just having a plan puts you further ahead than 75% of the population. I would guess the details of your plan put you in the top 5% of people in your age bracket. I wish I had done exactly what you are doing ten years ago! Great job!

    • That’s extremely impressive! I’m 24, and I have goals to max out my HSA, Roth IRA (when I open one), pre-pay my mortgage, and max out my 401(k), just like yours. However, I’ve set my goals to be completed in 3 or 4 years. (I’m fighting my way through debt right now.)

      You sound like you have your financial life in order. What I would recommend, though, setting up an emergency fund that is independent of your Roth IRA.

      I don’t know your financial circumstances, so I’m making a lot of assumptions here. But at 23, I can’t imagine that you have contributed more than $15k into your Roth IRA. *IF* that’s the case, that’s not nearly enough for an emergency fund. Obviously, it would depend on your monthly expenses, etc. but you would need probably twice that amount in an emergency fund. Unfortunately, using your Roth IRA as an emergency fund, you’re limiting how much you can contribute to it per year and how you are able to access your money.

  9. I’ve been contributing to my Roth since I was an early teenager (not always a lot, but definitely some) on the assumption that I would use it to pay for college or for my first house. Turns out, I used it for neither. So it has a healthy sum.

    I do have a decent amount of cash in a money market savings account that can be accessed from an ATM, however, experience has shown that I can get money out of my Roth IRA faster than most online savings accounts (over-nighted check, rather than a 3 day transfer.)

    As for the amount of my emergency fund, I’m honestly not too concerned. I don’t have dependents (save for my dog), live in a low-cost of living area of the country, a highly flexible job in accounting, and access to more credit than your average 23 year old. I have enough life insurance to pay for any final costs I may have and enough disability to pay my basic expenses and then some. Until disability were to kick in, I would have no problem draining all of my investments and liquid accounts, which equivalent to a little more than one year of my salary. I also have enough equity in my house to sell it, pay off the mortgage and costs, and have money to spare.

    Anthony, it’s seriously encouraging to hear other people in their lower-20s that have their finances in order (or even care enough to be working on it.) Most of my friends have yet to wake up and smell the coffee (expensive coffee at that.)

  10. We’ve always lived free of consumer debt but had almost $50,000 in student loans to pay off (finished almost five years ago). We’ve built a three month emergency fund and have been prepaying our mortgage about 20%/month (just increased to about 26%). We save for little house upgrades here and there and since we live with one vehicle figure we ought to save cash for a second or a newer one when it is required. I feel good about all these choices we’ve made BUT worry sometimes that we’re not travelling with our kids a bit now, while they’re still at home with us. We spend carefully but still have money for the occasional pizza, music lessons, sports,etc., so our kids are certainly not suffering. But my husband and I always hoped to be able to offer travel experiences to our kids (we both travelled a fair amount before kids) and b/c we’re being so ‘responsible’ now I wonder if we’re making a mistake in this area!
    I don’t care about fancy clothes or vehicles or furniture…. but I don’t want to regret being too cautious with money while my kids were at home with us. My son (our oldest) is just heading into highschool. Any thoughts?

    • Kika,

      I’m the oldest of 5 children and while my family didn’t vacation a lot, my parents made it a priority to have a family day (Sunday) and stick to it. We spent a lot of Sundays going to state parks, local festivals, and local attractions. We went on two big roadtrips while I lived at home, but what I remember the most is picnics at the state park and kolaches at a neighboring towns’ Czech festival. Memories can be made close to home as easily as they can be at Disney.

      • Thanks for your thoughts, Melissa. I come from a family of twelve kids and we did lots of camping growing up – I have fond memories of it all. However, my husband and I are not campers so we won’t be offering this to our children. We have no desire to take our kids to Disney Land – rather we want them to see France, Quebec city, Italy. We are a multicultural/lingual family and had so wanted to offer this gift – love of cultures, languages, diverse people groups – to our kids; travel is one special way to offer this is.

        • Are you children old enough to be involved in the planning for a major trip? If so, let them know what you’d like to do but emphasize that there are major budget restrictions (kids understand that these trips are expensive). Turn it into a giant learning experience for your children. If the kids are on board, they may surprise you with their creative ways they can contribute to the trip and save on a daily basis. Maybe they would even choose to participate in a group sport because they place more value on being able to travel to amazing places.

          In the meantime, if you have access awesome museums and cultural events, you may be able to really add value by using these learning experiences to make your eventual trip that much more exciting.

  11. Encouraging to see some of the much younger with plans and goals all set out! Nice! Remember they are guideposts to guide your journey, and not ruts you are stuck in forever :) Adaptable and flexible are the keys.

    Mentally I just am so much more relaxed and at peace, content, with the feeling that the house is totally mine – I can live there til I die, and am secure in a paid for house thru my retirement years. So much easier to get by on very little when there is no mortgage payment. And for the naysayers who say it is never yours due to taxes and insurance….I think I can afford the under $1200/year (under $100/month) even on social security etc :) Where else could I live so inexpensively :) and with no fear of foreclosure nor eviction…… of course there’s always imminent domain, but that’s not on my worry list :)

  12. We’ve overpaid our mortgage by $160 a month since we bought our home in 2007. That is cutting a 15 year mortgage to 11.67 years and saving us about $15,000 in interest.

    We’re planning on increasing that overpay amount as soon as my husband’s car is paid off next year. That should cut the mortgage to about 10 years total.

    We also put in the minimum required to get the full company match on my 401k, fully fund a Roth IRA, and contribute monthly to our emergency fund, car and home fund, and our vacation account.

    We like that balance and the feeling of having all our bases covered.

  13. I believe paying off the mortgage is not a good idea considering you can use the money to gain higher return elsewhere. If that is not the case than one should payoff. Please note in mind that paying off doesn’t mean that it’s not costing you at all. You are still loosing interest on your principal for e..g if your house was worth $300k and you paid of $300k, that money could be in money market if you had not paid of especially it matters when interest rates are high. No matter what it will win eventually when rent/interest payment will caught up with $300k. Since I can not find a single investment which will guarantee to return more than what I pay in interest, I am with paying off as long as your other goal are met.

  14. People always argue that the same money invested would earn much more but all I know is I have been investing in a 401k at work for over 10 years and the only reason I have made ANYTHING is because I got a match. This mythical 8% return they are always citing doesn’t seem to exist. At least paying off my home is a guaranteed 5% return.

  15. Paying off your mortgage is a smart financial move 100% of the time, no matter what.
    You cannot say the same thing for investing in the stock market or any other financial asset.

  16. Great post and comments all! My only thought is to try to completely pay off something. That way, a sense of accomplishment will be enjoyed. Having a long-term goal of paying off a mortgage is good but also celebrate the small successes along the way.

    Brad :-)

  17. Paying of our mortgage is directly tied to being able to retire early. We’ve always had an accelerated schedule (paying every two weeks), rounded those payments up by ~$150/payment, and make additional extra payments every month or so when we save up a little extra. We should have it all paid off in a little over 10yrs from start to finish. Once that’s done we’ll likely work another 2 years or so to pay for one last round of major improvements and repairs like windows, roof, furnace, deck, refinish hardwood, furniture, major appliances, etc. We don’t want to go into retirement with any major expenses looming on the horizon. We’ve now saved enough to fund our retirement from 65 onward (in combination with government benefits and a small pension). Now getting the mortgage paid off and saving an additional pool of funds fo live on “pre 65″ are our priorities. The speed at which we payoff the mortgage and rack up those additional funds will determine how early we get to retire. Having an early retirement goal date in mind helps us stay focussed on cutting back in many areas of our lives so we can maximize mortgage payments and retirement savings.

  18. Another factor for us is that we’re not planning on staying in our current house very long. We’re still trying to put money towards all those “other things” mentioned in the Cons section, and the fact that we’re planning on moving in a few years doesn’t give us much motivation to take away from those items to put more towards our house. Obviously we would benefit from putting extra money towards our mortgage even though we are moving soon(ish), but it’s not at the top of our priority list. Once we find a more permanant residence, we’ll obviously put money towards other forms of savings, as well as paying off our mortgage early. Yet another factor in the debate!

  19. Let me start by saying that I don’t own a gun to dispel the survivalist image I’m about to portray, but the nice thing about owning your home is that you own it. Meaning, no one can kick you out. If society goes to hell and the economy collapses (I mean anarchy, not recession), there won’t be any banks evicting you as everything unravels.

  20. Are you children old enough to be involved in the planning for a major trip? If so, let them know what you’d like to do but emphasize that there are major budget restrictions (kids understand that these trips are expensive). Turn it into a giant learning experience for your children. If the kids are on board, they may surprise you with their creative ways they can contribute to the trip and save on a daily basis. Maybe they would even choose to participate in a group sport because they place more value on being able to travel to amazing places.

    In the meantime, if you have access awesome museums and cultural events, you may be able to really add value by using these learning experiences to make your eventual trip that much more exciting.

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