Getting rid of your debts and saving money on interest payments is normally a great idea. But paying off your mortgage might not be quite as good of an idea as you might think.
We will look at the things you need to consider before you choose to pay off a mortgage early.
Pros and cons of getting rid of your home loan
There are many benefits when you pay off loan early, but whether it is right for you will depend on many things. First, let’s take a look at the benefits:
The pros:
Available cash
If you don’t have mortgage payments to make, you can do other things with your money. Investing this money could earn you more than your home loan would have cost. If you choose to invest in an index-linked fund, in the longer term, you should be better off.
Investing is a risk, however, and even though this is historically a good investment, you might not see the same returns. Investing in Treasury bonds and certificates of deposit are a safer option, though the returns are unlikely to be as good.
Saving money on interest
Much of the money you pay each month to your lender is interest. Paying the mortgage sooner than you need to, reduces the interest you will pay to the lender.
It is possible to save thousands in interest when you pay more toward your mortgage. However, you need to be sure that extra payments are going toward reducing the principal, and not simply paying interest.
Debt freedom
Without a large loan hanging over your head, you will feel freer. You won’t have to worry so much about maintaining your income, and more options will be open to you.
Owning the property
If you have a mortgage, the lender will own a large part of your home. But when this is no longer the case, you will have fewer things to worry about should your finances become worse.
The cons:
Investing could be more profitable
While paying your mortgage reduces your monthly payments, investing the money you would have used to pay the home loan could produce better results. Historical stock market returns of around 8-9% on average, is a better use of your money if the interest rate on your mortgage is a lot less.
This could work out much better, but only if the stock market doesn’t nose dive in that time.
Access to your cash
With more of your money tied up in your home, it will be more difficult to get access to it if you suddenly need to. You could sell the home, but this will take time. Instead, you could open an equity line of credit to make money available should you need it.
Fees
When you pay your mortgage early, the lender will miss out on some of the interest you would have paid on the loan. To counter this, there could be a prepayment penalty if you pay it sooner.
While not as common as they used to be, it’s essential to check the terms of your mortgage before deciding to pay it off early.
Tax deductions
The interest you pay on a mortgage can be used as a tax deduction. If you pay off your home loan early, this will no longer be available to you.
Along with the capital gains exclusion, tax deductions are one of the best financial perks of home ownership.
Credit score
Part of your credit score is based on the different types of loans you have. Removing the mortgage from this will reduce your score. Though it won’t be a huge change, it could be something that you need to consider.
Is paying off your mortgage early the right choice?
There are many things to consider, like how close you are to retirement and if you have other debts, before you decide to pay off your mortgage.
If you are near retirement and you intend to stay in the home, reducing your monthly outgoings will be beneficial. If you have other debts, they should be paid off before a mortgage with lower interest charges.
If you are further away from retiring, investing in the stock market could really pay off. Though your willingness to risk money in the stock market and the economic conditions will also be a factor.
Whether paying off your home loan is the right option for you, isn’t an easy decision. Though being clear on your financial goals and being realistic about your situation, will make this choice easier.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell MetroWest Massachusetts real estate for the past 35 years.
