Eighty percent of Americans hold some form of debt and the most common type is mortgage debt (44%). For most people, buying a house is the biggest investment they’ll ever make, and the purchase typically means decades of monthly payments. That’s a big financial responsibility, but if you’re in a position to pay off your mortgage early, should you? Surprisingly, the answer is not an automatic “yes.” It really depends on your personal financial situation as well as how you’d accomplish it. Here’s what you need to know.
How to do it
There are several ways to strategize your accelerated mortgage payoff. The best method depends on your current financial position and preferences:
- Increase your payment amount each month — Start by setting a goal, such as paying one extra monthly payment per year. You can accomplish this by dividing your monthly payment amount by 12 and then tacking that amount on your regular payment each month. Always make sure that any extra money you’re paying is directly applied to the principal rather than interest.
- Increase the number of payments each month — Another tactic is to make a payment every other week instead of monthly, which you can accomplish manually or by enrolling in a biweekly mortgage payment plan. Be advised, however, that sometimes these plans are managed by a third party that enforces additional fees or rules; if that’s the case, just set up a reminder for yourself to make the biweekly payments toward the principal on your own.
- Make a payment with any windfall or uptick in income — Have you received a bonus at work? An inheritance? A hefty income-tax refund? Lottery winnings? (Hey, we can all dream.) These are all great opportunities to put a one-time lump sum toward your mortgage principal.
- Refinance your mortgage to a lower rate — Refinancing your existing mortgage could result in a lower monthly payment amount. If you keep making the original higher payment amount, you will pay off the debt years sooner and pay less interest.
- Refinance your mortgage to a shorter term — Alternatively, if you find that you’ve paid off about 10 years on a 30-year mortgage, refinance to a 15-year mortgage instead to get you closer to the end date.
Like any other big decision, there are pros and cons. Consider the following:
- You can potentially save thousands of dollars on the additional interest you’d pay over the course of the mortgage term.
- If you plan to stay in your home for the long haul, it makes sense to expedite the payoff so you remove part of your housing costs (although you’ll still need to pay applicable taxes, insurance, repairs, and upkeep).
- Removing a mortgage payment from your monthly payouts frees up money for other needs and opportunities.
- Many people believe the ultimate peace of mind is knowing you own your own home outright. For example, if you lost your job or had to take a pay cut, you can rest easy knowing that you don’t have to make monthly mortgage payments.
- By diverting excess cash to pay off your mortgage, you are making this cash unavailable to work toward other goals. If you have student loans or credit card debt, for example, you should put any extra money toward these first, especially if they have higher interest rates than your mortgage. Consider other needs, as well, such as retirement savings, emergency funds, and investments.
- You may not be able to itemize tax deductions if you no longer have mortgage interest.
- Your retirement is put at risk if you tap into retirement savings to pay off the mortgage. In general, this strategy is considered risky and is highly discouraged.
- You could potentially face prepayment penalties. Check your mortgage paperwork for a “prepayment penalty” or “prepayment disclosure.” Typically, prepayment penalties are a fixed fee, but some are based on a sliding scale based on how long you’ve held the loan.
As you’re thinking about whether to put extra money toward your mortgage for an early payoff, first consider needs that are potentially more pressing and deserving of your extra funds. Do you plan to help pay for your kids’ college tuition in a few years time? Do you dream of renovating your outdated kitchen? Only you can prioritize what your most immediate financial needs are.
Second, if you decide to pursue an accelerated mortgage payoff, always make sure that any extra payments you make are going directly to the principal and not toward interest on the mortgage loan. And finally, consult your Financial Advisor and tax professional to help you decide if an early mortgage payoff is a good plan for you.