If you own a home, you’ve probably wondered whether it’s worth paying off your mortgage early. And if so, you are not alone. Many homeowners wonder how they can get their mortgage off faster, or if getting their mortgage off faster is the smartest way to spend their money.
Before making a decision, consider the math and potential benefits.
Should I pay off my house?
When it comes to whether or not you should prepay your mortgage early or not, there are certain people who just argue about the financial implications of that decision. On one side of the equation, you have experts saying that if you are tied to a low interest rate, you shouldn’t prepay your mortgage. Their reasoning is that you’d better invest your money in the stock market, where a reasonably diversified stock portfolio can average at least 7% over the course of a decade or more.
In other words, you wouldn’t want to pay off a 4% APR mortgage if you can get a higher return by investing in stocks and bonds through a brokerage account, or by increasing your pension contributions. Add the home mortgage interest deduction that you can apply on your federal taxes and it means you’d be stupid to prepay your mortgage and miss out on those perks.
When it comes to people seeing the mortgage prepayment problem in black and white, it’s all about math. After all, why repay a 3% or 4% loan early and lose part of a valuable tax deduction when you could invest that money instead and make significantly more?
But prepaying your mortgage also has an emotional side to mortgage
Still, there are plenty of people who ignore the math and move on with their mortgage prepayment plans. My parents fell straight into that category. Instead of taking the usual 30 years to pay off their mortgage, they paid it off in less than 20 years.
Ask them if they care about the tax deduction they missed and they will likely look at you like crazy. Why? Because when they made the prepayment decision, they never cared about the math; it was about their financial freedom. Aside from the math, they have never regretted their decision to pay off their house and get completely debt free.
And a lot of people agree with this feeling. For some people, like my parents, it all boils down to the fact that they just don’t like debt. As simple as that.
I too follow in their footsteps. We took out a 15-year mortgage four years ago and I’ve been working hard to pay it off ever since. We live in our eternal home after all, but that doesn’t mean I want to pay it off forever. As of this writing, I have to make a payment on my mortgage before we are completely debt free. If you are reading this, I have achieved my goal. Ask me in a year if I regret it and I guarantee you I will say “no”.
Others, however, prefer deeper analysis. Whether you are a mathematician or just loathe debt, there are other pros and cons to consider.
Analyze advantages and disadvantages
The first is the home mortgage interest deduction, which many people claim when filing their taxes. With that in mind, let’s take a look at what the home mortgage interest deduction really means.
The easiest way to see your home mortgage interest deduction is to look at your effective tax rate. For example, suppose your total tax rate is 22%. On average, the home mortgage interest deduction reduces your taxes by $ 22 for every $ 100 you pay in mortgage interest.
That’s a pretty nice perk, but there is a caveat. Your mortgage interest deduction only applies to the amount you deduct beyond that Standard deduction, available to taxpayers who fail to submit their tax returns. As of 2018, the standard deduction is $ 24,000 for married couples and $ 12,000 for individuals. Also, the new tax reform bill passed earlier this year put a cap of $ 750,000 on mortgage interest deduction, which means you can only deduct home loan interest that is below that cap.
What does that mean? As of 2018, a higher standard deduction means fewer and fewer people are breaking down their taxes. And if you don’t list your taxes, your mortgage interest deduction is worthless. And even if you do, it’s only worth what it helps you save over the standard print anyone can take. In many cases, this drastically reduces the value of the mortgage interest deduction to the point where it is hardly worth considering.
But what about those lost investment returns? If you ask people if they are repaying their mortgage early and why, you will find many skeptics resisting the idea of taking on long-term debt in order to invest their extra dollars in the stock market. And when it comes to who is “wrong” or “right” there are several ways to look at it.
Since the stock market has done well in the past, the math favors those who choose to take low-interest mortgages and invest their extra dollars instead.
However, unlike the stock market, which is not guaranteed, the interest you save by repaying your mortgage early is a “sure thing”. Many people are happy to prepay and book the extra money they save from interest, even if it is less than they would have made by investing their extra dollars instead.
Different ways to pay off your mortgage early
Refinance your mortgage Most homeowners opt for a 30 year mortgage, but refinancing on a shorter term can result in lower interest rates and a shorter repayment period. It also saves you money on the total interest you pay on your loan, which is an added bonus.
Reformulate your mortgage – There are closing costs associated with refinancing a mortgage, so some homeowners are choosing to remodel their mortgage. The recast typically only costs a few hundred dollars in lender fees and allows you to lower your monthly payment by paying a one-time lump sum on your loan amount. This amount allows your lender to change your repayment schedule and reset your monthly payments without changing the interest rate or loan terms.
If possible, make an additional mortgage payment or two – Just one additional payment each year can cut the time it takes to pay off your mortgage by years. A common way to reduce the time it takes to pay back your loan is to make loan payments biweekly instead of monthly, for a total of 13 monthly payments instead of 12.
Lower your credit with a lump sum – Paying a lump sum to your financier will reduce your overall loan balance. Homeowners who receive cash inflow through labor bonuses, tax refunds, inheritance monies, settlement, or other sources may want to reserve those funds for this purpose.
How to cut a 30-year mortgage in half – Let’s say you have a mortgage of $ 200,000 for 30 years and you are paying $ 1,013 per month. By adding $ 500 per month, you will pay off the debt by 2035 instead of 2051, which will cut your debt length in half.
Tips on how to pay off your mortgage
- Check with your lender before setting up a plan to pay off your mortgage. Not every lender allows bi-weekly payments, and some have prepayment penalties for early principal payments. Knowing what you can and cannot do when it comes to paying off your mortgage early is important.
- Think about which payment options are best for your situation. Refinancing can mean shorter repayment terms and a lower interest rate, but it can also mean higher monthly payments and additional closing costs that you will have to pay. On the other hand, flat-rate capital or remodeling may not be feasible for homeowners who do not have access to large sums of money.
- Make sure you have an emergency fund ready. It can be tempting to invest every extra dollar in paying off your house payment, but make sure that paying off your mortgage early doesn’t come at the expense of a rainy day fund. It is recommended that you save three to six months on spending before diverting the money towards additional mortgage payments.
A balanced approach
As someone who loves math but despises debts, I see both sides of the problem. And that’s why my family took a balanced approach. My strategy has always been to primarily exhaust our retirement accounts and then toss a few hundred dollars more on the mortgage every month. Sure, our house is almost paid off, but that’s just because we’ve invested heavily all along, exhausted our retirement accounts, and met all of our other financial goals.
We could have paid off our house faster, but I didn’t want to save less for retirement. So we took an “all of the above” approach and did things in our free time.
At the end of the day, only you can decide how to handle your mortgage debt. If you hate debt, you want to leave it behind once and for all, and that’s understandable. But it’s also understandable that someone would make a decision based on the numbers alone. After all, math is hard to argue with.
So should you repay your mortgage early? It is and always has been up to you. Just make sure that every decision you make is an informed one.
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