“Should I pay off my mortgage early?” Seems like the answer should be a simple “heck yes!” But the smart answer is, “It depends.”
An early mortgage pay-off depends on a number of factors, including your adversity to carrying debt (personal preference), your ability to out-earn your interest rate (more on that in a moment), and your financial goals.
Why Pay Off Mortgage Early
Why would someone plan to pay off a mortgage early? Why go through the motions and expenses of borrowing money if you plan to pay it off in a few months?
Aside from the uber-rare homeowner who suddenly experiences a windfall of cash or lucks out with a big lottery win, someone who pays off a mortgage early usually knows they’re going to do this when they take out the mortgage, as our friend, mortgage lender Scott Morrow explained.
Scott has been in the mortgage lending business since 1996. He is branch manager and a market leader with Movement Mortgage LLC in Scottsdale, Arizona.
Most of the time when an early mortgage payoff happens, Scott said it’s because a homeowner was buying and selling a home at the same time. They might opt to take a mortgage to buy their new home first. Then, when their current home sells, they use the proceeds from that to pay off the new mortgage.
Regardless of the reason, Scott always recommends you consult with three people before you consider early mortgage pay-off: your lender, a financial or wealth advisor, and your accountant.
If you have a large enough reserve of cash to pay off a mortgage, you want to ask these three experts, “Does it make financial sense for me to pay off my mortgage, or can I invest that money elsewhere and out-earn my mortgage rate?”
Benefits of Paying Mortgage Early
Mortgage debt isn’t right or wrong, good or bad – it’s simply a matter of personal preference and how it fits into your long-term financial goals.
Paying off your mortgage early certainly has its benefits, especially if you seek the peace of mind of having a low debt-to-income ratio. For someone who is averse to carrying debt, it’s hard to put a value on how much a mortgage can add to that stress.
For others, a mortgage is a normal part of the American dream.
In short, the benefits of paying off your mortgage early might include:
- Reducing monthly payments so you can tackle other debts and expenses
- Improving your credit score and credit-worthiness
- Saving money on interest
Questions to Ask Yourself Before Paying Off Mortgage Early
When you meet with your financial advisors, you might ask them these questions (or they might ask you to consider these questions) before you decide to pay off your mortgage early.
- Do I have enough liquid assets (cash and cashable assets) to cover my monthly expenses plus emergencies?
- Do I have other debts, such as student loans and credit cards, with higher interest rates that I should pay off instead?
- Do I need to pay off the entire balance of the mortgage, or could I pay a lump sum and perhaps reduce my monthly costs by cancelling my private mortgage insurance?
- Could I instead invest that large sum of cash into another financial tool and earn more than I pay in mortgage interest?
- How will the paid-off mortgage affect my tax deductions?
- How will the paid-off mortgage impact my credit rating?
- Are there any prepayment penalties for early mortgage payoffs?
Regarding the last point about prepayment penalties, Scott Morrow says prepayment penalties are less common today than they were several decades ago. Today’s mortgage lenders rarely include penalties for paying off mortgages early.
“Also if someone is savvy enough to be able to pay off a mortgage early, they’re savvy enough to know about potential penalties,” he said.
Cost to Borrow vs Potential to Earn
The biggest question you need to ask yourself and your advisors is whether the amount you are paying to borrow money is more than or less than your potential earnings.
With mortgage lending rates at all-time lows (see graph below), some homeowners may opt to pay the 3% mortgage interest (which is also tax-deductible) and instead invest in financial tools that potentially pay higher rates of return.
Freddie Mac, 30-Year Fixed Rate Mortgage Average in the United States [MORTGAGE30US], retrieved from FRED, Federal Reserve Bank of St. Louis, April 27, 2021.
For example, say you have a 30-year mortgage valued at $250,000 and you’re paying 3%. You have $300,000 in savings, and you wonder whether you should use that to pay off your mortgage or invest toward your retirement.
Your financial advisor, wealth manager or accountant can help you create different scenarios so you can weigh the costs and benefits of paying off your mortgage early.