Should I pay off my mortgage early?
Al Seguin, CPA in San Antonio Texas says he often hears this from clients who only have a few years left on their mortgage. “That’s one of the most common questions that I [hear],” he explains. “People will say, ‘Al, I just don’t like debt.'”
1. Your interest rate. Seguin points out that if you had a mortgage with a 4 percent interest rate, the net borrowing cost could be as low as 3 percent after factoring in the home-mortgage interest deduction on your taxes. However, if your mortgage is mostly paid off, the tax deduction is less attractive since at that point, you’re mostly paying down principle.
In some cases, Seguin advises clients to refinance rather than pay off their mortgage ahead of schedule. “You can refinance for dirt-cheap rates, and that typically will make sense for people carrying mortgages at high interest rates,” he explains.
2. Your investment options. Consider where the money will be coming from and whether you might get a higher return by using it in other ways. “If you take $50,000 out of your portfolio, you’re likely going to have to pay taxes on it, and that $50,000 can potentially earn more than 3 percent per year,” says Seguin. “The math says that extra payment should go into your investment account.” If you’re skittish about investing the money, Seguin says prepaying the mortgage may be a better option than earning less interest in a savings account.
If your money is in high-risk investments, it could earn a higher return than your mortgage—only there’s no guarantee. lower-risk alternatives are the appropriate benchmarks.
3. Your other financial obligations. According Seguin, it’s a good idea to prioritize higher-cost debt like credit-card debt and other loans over prepaying your mortgage, since those debts cost more money in interest. “Think about whether you’ll need that extra money for other major purchases,” he adds. “Will you need to borrow more for that car or wedding?” If the answer is yes, you may want to stick with your mortgage’s original payment schedule.
4. Your need for liquidity. Think twice before prepaying your mortgage if it would require you to empty your emergency fund or otherwise sacrifice liquidity. Being able to do so from your savings account or your investment account is a much cheaper way than going into your house to derive those funds. Weaver advises most people who prepay their mortgage to do it through extra monthly payments, which offer more flexibility than a lump-sum payment.
Also consider job stability as it relates to liquidity. However, if you prepay your mortgage and open a home equity line of credit, you may still have access to that money at an affordable rate. (assuming rates don’t rise anytime soon)
5. The sense of security you get from owning your home without any debt can’t be quantified, but it’s certainly worth considering. “People feel better not having any debt on the balance sheet as they go into retirement. As a general rule of thumb, it is recommended that they try to reduce their required monthly bills, so paying off the mortgage gives much more flexibility in their monthly expenses.” says Seguin. However, that rationale only applies if you plan to stay in your home long-term so you can enjoy mortgage-free living. If you’re planning to downsize once you retire or move for other reasons, you might not reap the same benefits of an early payoff.