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):
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.
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:
- Paying off credit card debt
- Building an emergency fund
- Contributing as much as you can to a retirement account such as your 401(k), IRA or other form of retirement savings
- Saving money for college for your children
- Building a Health Savings Account (HSA)
- Setting aside cash for a much-wanted vacation
- Home improvements
- Starting a car replacement fund
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.