Paying down your mortgage can help you save money and gain peace of mind, but it can also prevent you from making other important financial moves. This guide will offer insight into when it’s a good idea and how you can get started.
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Being debt-free is a great goal. It may be a good idea to pay off some types of debt as quickly as possible—like credit card balances. But is it a smart financial decision to pay off your mortgage early?
That actually depends on your financial situation. Paying off your mortgage early comes with both benefits and drawbacks.
This guide will show you what to consider first, how to pay off your mortgage early, and some alternatives to consider.
Before you decide to pay off your mortgage early, consider potential opportunity costs along with the benefits of eliminating that mortgage debt. Here’s what to keep in mind as you make your decision:
Other debt: Review your existing debts and identify which have the highest interest rates. Pay off your higher-interest debt first, especially credit card debt. This will save you money in the long run.
Retirement savings: Paying off your home loan may lead to short-term gains, but maxing out your 401(k) can have long-term advantages and financial perks, such as a big tax deduction. If you have to choose, invest in retirement to ensure you have enough money to retire.
Emergency savings: Emergencies happen, and they can be expensive. Don’t tie up all your net worth in your home. Maintain some level of liquidity (i.e. money you can spend) and build an emergency savings account before you put extra money toward your mortgage.
Other financial goals: Do you need a new car soon or plan to finance your child’s education? Don’t pay off your mortgage balance only to take on more expensive debt like car loans or credit card debt to finance other needs.
Prepayment penalties: Does your mortgage agreement include prepayment penalties? If so, the extra fees may not make paying it off early worth the effort.
How long will you stay in your house? If you plan to move soon, it doesn’t make sense to pay it off. Instead, save up for a down payment on your new home.
How close are you to retirement? If you plan to retire soon, investing extra makes less sense because your risk tolerance lowers near retirement. So it could make sense to put extra cash toward your mortgage repayment.
Monthly cash flow: If you have a windfall, such as an income tax return or a life insurance payout that will allow you to pay off your mortgage early, it could prevent you from struggling with monthly payments in the future.
Peace of mind: When you pay off your mortgage, there’s one less bill to worry about, more freedom to make other investments, and no fear of losing your home. Paying off your mortgage early can give you that peace of mind.
Your financial habits: If you don’t put extra money toward mortgage payoff, will you realistically invest or save the extra money? If you’ll likely just up your cost of living, you’re better off paying down the mortgage now.
Proponents of investing point to your return on investment and the importance of saving for retirement. Is it always the right answer?
That depends on your goals. If your goal is to maximize your overall return, then investing is likely the better option. The average annual return in the stock market can hover between 7% and 10%. If your mortgage rate is lower than that, as most are, you’ll see a bigger return through investment.
But before you invest, thoroughly review your options and develop a plan on how to invest your money for the greatest return. Depending on your goals, you could put your money in:
The market, however, can be volatile. If your risk tolerance is low—such as it is near retirement—paying off your mortgage may be a better option for you. In addition to saving on interest, you’ll gain equity in your home.
Though this may result in lower returns than a retirement investment, it will give you a reliable asset and a predictable return.
Pros & cons of paying off your mortgage early
Removes what can be a major long-term debt burden.
Provides peace of mind.
Can save you thousands of dollars in interest.
Increases your home equity.
Other investments may yield a higher rate of return.
Lack of liquidity.
Potential prepayment penalties can make it less beneficial.
Can prevent you from paying off higher-interest debt.
May make it harder to save for other financial needs, like emergency funds or educational expenses.
Ways to pay off your mortgage early
If paying off your mortgage early is right for you, here are few things to keep in mind as well as some popular methods of paying down your mortgage faster:
Avoid prepayment penalties: Before you make any plans for early repayment, check your mortgage agreement or contact your lender to find out what, if any, prepayment penalties you’ll incur. Devise a repayment plan that avoids penalties.
Pay toward principal: Your monthly mortgage payment goes toward the principal balance as well as interest (and escrow, if it’s included). If you want to pay off your mortgage early, make sure extra payments go toward your principal balance and not just future interest payments.
Make two payments per month: Depending on your timing, making two payments a month will result in the same annual payment but can reduce the total interest accrued.
Paying your loan bi-weekly: If you pay half of your total loan payment every two weeks, you’ll make 26 half-payments a year, which is 13 full payments a year. You’ll save on interest and get one month closer to early payoff each year.
Make one extra payment per quarter: If you want to pay your mortgage off faster, make an extra payment every three months. This will result in four extra payments each year.
Refinance for a low interest rate: Refinancing with your existing lender or another mortgage refinance lender may lead to a lower mortgage interest rate and lower monthly payments. However, refinancing often includes a down payment and closing costs, so it’s not always worth it. Get quotes first to see if you could score a lower rate.
Pay it off in a lump sum: If you have a windfall, sometimes the easiest way is to simply pay off your debt in one lump sum. Before you do, determine whether prepayment penalties will come in to play, and whether your money would be better spent elsewhere.
What happens when you pay off your mortgage?
Once you make that last payment, you’re done, right? Unfortunately, not quite, but you’re close. Paying off your mortgage isn’t as simple as sending in one final payment. There are a few extra steps you’ll need to take to be free and clear.
You’ll receive what’s frequently known as a mortgage release or mortgage satisfaction documents. This includes a statement that shows you’ve paid your mortgage in full.
The lender will file paperwork with your county government that releases your deed, signaling that you own your house outright. This process can take several weeks. Just contact your local government to confirm that it’s done.
You’ll need to update both your insurance and property tax information to make new payment arrangements. This is important if you previously paid your taxes and homeowners insurance through escrow.
Need more help deciding whether to pay off your mortgage early? The best thing you can do is consider repayment scenarios to determine what makes sense. Our calculators can help you get started.
Use our mortgage calculator to determine what your monthly payments would be if you set a shorter repayment timeline for yourself. And use our mortgage refinance calculator to see how much you could save by refinancing your mortgage with another lender.
Author: Jennifer Lobb
Jennifer Lobb is a small business and personal finance writer. She has a passion for writing and her work has been featured in a number of online publications and media outlets, including MSN, Inc., and more. Jennifer is a graduate of University of Denver and received a MA with a focus in Literature, Culture, and Arts Management. When she’s not writing, she can be found with a good book in hand or whipping up something creative in the kitchen.