Soon after signing mortgage loan documents that lock in a 15- or 30-year debt, homeowners dream about paying off the debt early to get rid of the monthly burden. But, even if you could pay the mortgage off early, is it a good idea?
When Considering Paying Off a Mortgage Early
It would be nice to own a home free and clear. After all, paying off a mortgage loan early can save thousands of dollars in mortgage interest payments. But what are the costs and sacrifices one must make to do this?
Homeowners contemplating early mortgage payoff should consider these questions:
- Should I consider allocating a portion of our current income to make regular early payments?
- What if we direct a big chunk of our accumulated nest egg or inheritance to pay off the mortgage?
- If an emergency arises, will we still have the money to address it?
Answers to these questions depend on individual circumstances and their mindset.
First Things First
Redirecting cash flow to pay off a mortgage early can leave homeowners unprepared for future life events or emergencies. Before considering an early mortgage payoff, homeowners need to be confident in their financial situation. Outright homeownership can be a safeguard against some forms of financial disaster. However, according to Business Insider, saving for retirement, building an investment portfolio, paying life insurance premiums, and saving for college are also essential.
In nearly every instance, a home is an excellent investment that will appreciate significantly throughout the life of the mortgage. However, home value appreciation occurs with or without a mortgage in place.
Advantages of Paying Off a Mortgage Early
Probably the primary benefit of prepaying a mortgage is personal peace of mind. No matter what else may happen, the mortgage-free homeowner will not have to worry about where they will be living.
Secondly, borrowers pay less total interest overall when paying off their mortgage early. For example, if an individual borrows $250,000 with a 30-year, fixed-rate 3.5% mortgage, the total interest accumulated over the life of the loan would be about $154,000. Prepayment of this mortgage after ten years would reduce the total interest payout by at least 50% since the interest owed decreases slightly with each month’s payment.
Without the burden of a mortgage, the improved cash flow can be a motivating factor to pay early. With the mortgage expense removed from the monthly budget, homeowners can do more with the savings.
Disadvantages of an Early Mortgage Payoff
Paying off a mortgage balance can drain a savings or investment account and require starting over to rebuild them.
It is easy to overlook opportunity costs. Financial advisors explain that lost opportunity costs represent the potential benefits an individual can miss by paying off a mortgage early. The expense of paying off a mortgage early would mean the loss of earned investment gains if the funds remained in an investment account.
Understanding potentially missed opportunities when choosing one investment over another allows for better financial decisions. With the average interest gains over a decade being about 10% per annum, paying off a 3.5% mortgage would seem like the wrong choice.
Homeownership should be part of any investment portfolio along with stocks, bonds, CDS, and more. Prepaying a mortgage may hamper diversifying wealth across various investment types, leaving homeowners vulnerable to drops in real estate values.
It is important to remember that homes are not liquid assets. Therefore, should an emergency arise, homeowners can be at risk if they apply too much wealth to pay off a mortgage.
Finally, mortgage interest is tax-deductible for those who itemize their income taxes. One way to look at this is that low-interest rates become even lower when tax deductions are considered.
Consider Your Circumstances
Paying off a mortgage loan can provide a great sense of accomplishment. However, any euphoria may quickly fade should a crisis occur and the homeowner finds they are short of liquid assets.
The most important consideration for homeowners is to ensure all other financial bases are covered and that liquid assets will be available for emergencies. A long-term plan that encompasses projected expenses and obligations, plus a sound investment portfolio, should be in place before paying off your mortgage early.
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