Why you should not pay off your mortgage early
Making extra mortgage payments can take away from other financial goals
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Whether you just moved in last year or have been in the same home for a decade, you’ve probably imagined how freeing it would be to live a life without monthly mortgage payments. In a recent Principal Financial Services survey, 34% of respondents said paying off their mortgage was a top financial goal.
But when you’re deciding if you should pay off your mortgage early, you have to look at your whole financial picture — total debt, total savings, etc.
“Paying off a mortgage early is a personal financial decision that depends on individual circumstances and goals,” said Adie Kriegstein, a licensed real estate salesperson at the real estate company Compass. “While some homeowners prioritize paying off their mortgage as soon as possible, there are several reasons why others may choose not to do so.”
- Paying off your mortgage early limits your ability to invest in other higher-yield opportunities, such as retirement accounts or diversified investment portfolios.
- Mortgage interest payments can be tax deductible, providing potential savings.
- Putting all your financial resources into your home can increase your investment risk due to real estate market fluctuations.
You’ll miss out on tax advantages
Having a monthly mortgage payment can come with tax perks. The biggest tax benefit is that homeowners can deduct the interest paid on their mortgage from their taxable income.
“The interest paid on a mortgage is often tax deductible, reducing the overall tax liability,” said Kriegstein. “This benefit can contribute to significant savings, particularly for homeowners in higher tax brackets.”
Other tax breaks homeowners can enjoy are:
- Deducting property taxes
- Avoiding capital gains tax if selling owner-occupied property
- Energy-efficient upgrades
- Home office expenses for self-employed individuals
Paying off your mortgage early can hurt your retirement savings
Don’t neglect your retirement savings in favor of paying off your home faster. Not only are you jeopardizing your long-term financial security, but you could be missing out on money-saving tax benefits. Contributions to retirement accounts like 401(k)s or IRAs offer tax advantages that can bump you into a lower tax bracket, meaning you can owe less when April rolls around.
Additionally, if you forgo contributing to your retirement savings, you might also be neglecting your employer’s retirement matching program. If your employer will match your retirement savings 100% for the first 3%, that is essentially like getting a bigger paycheck without asking for a pay raise.
For example, say you make $100,000 and contribute 3%, which is $3,000, to your retirement fund. Your employer could match that with an additional $3,000. If you don’t contribute to your company-sponsored retirement program, you’d be leaving that free money on the table.
Plus, any money you invest in your retirement today will have the power of compound interest to help it grow. If you put off your retirement savings to pay off debt, you miss out on the chance of having your savings compound.
Let’s look at two examples of how that could break down:
- A 25-year-old who consistently saves $500 per month in an annually compounding retirement account with an annual return of 7% until the age of 65 will have about $1,197,811.
- Starting that same scenario at age 35 would give the person only $566,765 by the time they hit 65.
So, the 25-year-old contributed $60,000 more but has earned over $631,000 more due to the power of compounding.
You can earn higher returns with other investments
If you’re devoting more funds toward your mortgage repayment than other savings vehicles, you could be missing out big time. This is especially true if you’re repaying your mortgage at a lower interest rate than what the current annual percentage yields (APYs) are, or if you can refinance in order to do so.
Yes, your home is an investment. And hopefully you will one day sell your property for more than you bought it for (if you so choose). However, it’s best to diversify your savings and never keep all your money in one investment. Evaluate the potential returns and growth opportunities offered by other savings vehicles, such as:
Other debt could have higher interest rates
Not all debt is considered bad debt. Mortgage loans are considered “good” debt because it’s backed by your home and can increase in value over time. Plus, mortgages come with relatively low interest rates compared to some other loans like credit cards and personal loans.
Focusing on your higher-interest debt first can help you save more in the long run. It’s also simply more motivating to pay off a credit card, auto loan or personal loan than to tackle a 15- or 30-year mortgage.
It can increase your investment risk
Putting all your financial resources into your home can increase your investment risk, primarily due to fluctuations in the real estate market. While real estate has historically been considered a stable investment, there can be seasons of low home prices or situations where an area loses property value significantly.
Remember: it is important to diversify, since you want to spread out the risk for long-term growth.
It can affect your liquidity
Emergencies happen, and when you need cash fast, your home is not the best place to look. If you put extra money in your home rather than into an emergency fund, it’s going to be difficult to access it.
While you’ll be able to use your home equity through a cash-out refinance or home equity line of credit (HELOC), these are typically for home projects or non-emergency needs. Plus, both of these options can take time to set up, especially if your lender requires an appraisal (and many do). Most importantly, with these options, your home acts as collateral — which means if you don’t pay, your home could be seized and used to pay down your debt.
» MORE: Best ways to borrow money
Should you choose a 15-year mortgage term to pay off your home faster?
There are plenty of people in the personal finance industry who recommend a 15-year mortgage to help you get out of debt more quickly. However, a 15-year mortgage loan vs. a 30-year mortgage loan is more stressful to your budget — which is fine for those who can afford it, but may be cutting it too close for those who can’t.
Having a 30-year mortgage and making extra payments can help ensure you aren’t stuck making a bigger payment if money is tight one month. That said, 15-year mortgages tend to come with lower interest rates than 30-year loans because the lender is taking on less risk.
Can I get a home equity loan if my house is paid off?
Yes, if your home is completely paid off, you have full equity in your home, meaning you can typically borrow more. You can typically get a home equity loan for terms ranging between 5 and 30 years.
Can I make extra payments on my mortgage without paying it off early?
Yes, anyone can make extra payments. Contact your lender to tell them you want to make an additional payment toward your principal rather than just sending in the money (some also allow you to select this option on your online portal). This way, the lender can apply your extra payment the way you want instead of it counting toward next month’s mortgage payment.
What are the penalties for paying off my mortgage early?
You can face a prepayment penalty if your lender disclosed that in your documentation. Some states limit how long this prepayment penalty is enforced, and it typically drops off after the first few years.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- Principal Financial Services, "Retirement can look different from today's evolving workforce." Accessed May 29, 2023.
- U.S. Securities and Exchange Commission, “Compound Interest Calculator.” Accessed June 21, 2023.
- Consumer Finance Protection Bureau, “Can I be charged a penalty for paying off my mortgage early?” Accessed May 30, 2023.
- IRS, “Publication 936 (2022), Home Mortgage Interest Deduction.” Accessed June 12, 2023.
- IRS, “Publication 530 (2022), Tax Information for Homeowners.” Accessed June 13, 2023.
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