A mortgage is likely to be the largest debt a person holds. Therefore, it isn’t surprising that people will rush to pay off their mortgage as soon as possible.
However, we seriously encourage you not to do that. There are several reasons why you should not be paying off your mortgage early.
In this article, we want to take a little look at a few of these reasons.
You May Have Debt That Has a Higher Interest Rate
The chances are pretty high that you have debt that has a higher interest rate than your mortgage. While the debt is likely to be smaller than that of your mortgage, it is still debt. It needs to be cleared as quickly as possible.
If you have spare funds available each month, then it is going to be much better for you to pay off other debts that you have. While it may not save the thousands of dollars from paying off your mortgage early, it will likely save you hundreds of dollars in a shorter period of time.
Paying off smaller debts is likely to have a much larger impact on your credit score than paying off your mortgage, which, in many cases, isn’t factored into your credit score that highly.
We would always suggest that you pay off any other debts before you even touch your mortgage. In fact, if you add it up, we can almost guarantee that your monthly expenses/payments on other debts may come close to the amount that you are spending monthly on your mortgage.
You Are Tying Up Your Money
While it can be tempting to pay off your mortgage early, every bit of cash that you spend on your mortgage cannot be used anywhere else.
It is suggested that before you even think about paying off your mortgage, you start to build up an emergency fund. It is recommended that this emergency fund extends to about 12-months’ worth of savings. This means that if you, sadly, lost your job, you would have 12-months of savings to fall back on. We know that it is going to be exceedingly difficult, but, if you can, we promise that your life is going to be a lot less financially stressful.
Hopefully, you will never need to tap into your emergency fund, but you will sleep far better at night knowing that it is there.
Did you know that the interest paid on your mortgage can be offset against your taxes? In fact, you could drastically reduce the amount of tax that you pay each year when you factor in the interest paid on your loans.
If you pay off your mortgage early, then you will be kissing goodbye to these tax breaks. Once that mortgage has gone, you won’t be able to deduct the mortgage interest, and thus you will likely end up paying more tax per year.
While this increase will not be anywhere near as much as you paid for your mortgage, why would you want to quickly give up something that can reduce your tax obligations each year? You could potentially save hundreds of dollars on your taxes as long as you have your mortgage in place. Therefore, it makes sense to keep it.
It isn’t just the interest on your mortgage that you need to think about when it comes to tax breaks. If you invest money into an IRA or 401(k), then that is another tax break you can take advantage of. This will reduce your tax obligations further. It is better to pour your cash into an IRA or 401(k) than it is to pay off your mortgage. You get two awesome tax breaks that way.
Yes. We are oversimplifying this a little bit, but, honestly, almost everybody could save money on their tax return if they still have a mortgage in place.
Investments Will Pay Off More
Many people do not realize this…but you will make more money by investing your cash than you would save on interest rates paying off your mortgage early.
In our opinion, rather than paying off your mortgage early, you should look for less risky investments to make like ETFs or even bonds (below is an illustration of how an ETF works—in one investment purchase you receive three or maybe even 10 different companies in the same investment pie ).
If you do not know how to do this, don’t fret. There are plenty of companies that can help you out. In many cases, you will not be choosing the investments yourself. Instead, you will be putting your cash into an investment fund.
Obviously, investments will carry a small amount of risk. However, when they do offer rewards, the rewards are going to be a whole lot better than if you paid off your mortgage early. You could probably end up with a nice bit of cash extra each month to spend.
You May Lose Your Job
We know that these links ever so slightly into the point of putting together an emergency fund.
Think about this situation:
John and Linda have been making double mortgage payments for 6 months, then Linda suddenly loses her job. The couple now regret the lost cash sunk into their mortgage because they have zero saved and another mortgage payment due next month.
We have seen plenty of situations where people have been excited to make larger payments on their mortgage and other debts, only to find that they cannot afford anything the next month.
In 2020, we have already seen how easy it can be to lose your job overnight, even if you felt that you were in a stable position.
You Have a Fixed Interest Rate Mortgage
We have never seen that much sense in paying off a fixed interest rate mortgage early. it is protected against a rise in interest rates.
This is always nice to have, particularly when the other expenses in your life are not going to be protected from inflation. As other costs in your life rise, it will almost feel as if your mortgage is your one constant.
Some Lenders Will Charge You for Paying Your Mortgage Back Early
You may need to dig into the terms and conditions of your mortgage to find out exactly what your mortgage entails.
Obviously, the main reason why a lender is handing you a mortgage is that they expect to make money from you. If you pay back your mortgage early, they are not making as much as they would have done.
As a result, a lot of lenders will charge early repayment fees for your mortgage. In some cases, these early repayment fees may come pretty close to what you would have paid in interest.
This means that you are not going to be saving any money if you pay back your mortgage early. All you are doing is damaging your budget in the short term.
You Need a Retirement Fund
It is never too early to plan for retirement. While we did mention earlier that you should have at least 12-months of income stored in your bank account ready to tap into at a moment’s notice, it is also wise to start building up a retirement fund. This means that you will not be working yourself to the bone during your twilight years.
Paying Your Mortgage Off Early Will Take a Long Time
Unless you have suddenly come into a lot of money, paying off your mortgage early is still going to take a huge amount of time. At most, you are probably going to be paying off your mortgage 5-years early. This may seem like a long time, but it isn’t.
Not when you consider the fact that mortgages could be 25-years long. You are only saving a fifth of the time on your mortgage.
Surely, rather than saving a small amount of time on your mortgage, it would be better to put your money to better use in other ways?
Unless you are paying off decades early, you won’t be saving a whole lot of money in terms of interest either. It seems rather pointless, particularly since the whole reason why people pay off their mortgage early is to save money.
When Should You Pay Off Your Mortgage Early?
We have talked a lot about some of the reasons why you should avoid paying off your mortgage, so we want to wrap up by talking a little bit about the times when you should be paying off your mortgage early.
At the very minimum, you should only be paying your mortgage off early if you have 12-months of savings in place. Ideally, you would have made a few investments here and there too which may help to offset a loss in a job for a short while beyond the 12-months. If you do have a sizeable amount of savings, then you can make a few extra payments on your mortgage here and there.
If you have no other debts that need to be paid, then you may also want to consider paying a little bit extra on your mortgage each month. It doesn’t have to be too much. An extra $100 to $200 per month can make all the difference when it comes to saving money on mortgage interest rates.
Finally, only pay off your mortgage if you have a few years left on it. If you have ten to twenty years left on your mortgage, then it doesn’t make any real financial sense to pay off your mortgage early.
To review, when it makes sense to pay off your mortgage early:
- Your emergency fund and investments are set
- Your mortgage is near the end of its loan term
- You have a sizeable retirement savings
In most cases, it does not make financial sense to pay off a mortgage early. There are so many other, far better things that you could do with your money. Only pay off your mortgage early if you have exhausted all over money-making options available to you, and you have enough savings to keep yourself going for a year. If you do anything else, you are just doing yourself an injustice.