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Key takeaways:
- Whether it makes financial sense to pay off your mortgage early depends on several factors. And regardless of whether it’s a good financial decision, sometimes it’s a good decision simply because it allows you to sleep better at night.
- If you decide to pay off your mortgage early, check to ensure that your mortgage lender has no prepayment penalty and make sure the extra money you pay goes towards paying down principal, not interest.
- Simple changes can result in big savings. There are even things you can do that require little to no extra money.
Ever wonder what you could do with all that money if you didn’t have to make a mortgage payment every month? Many people dream about paying off their mortgage early, and it’s a solid goal for those nearing retirement. But is it a good idea for everyone?
As with most things financial, the answer depends on a lot of factors, including your current mortgage interest rate, your emergency savings account balance, your personal situation with other debt, and more.
Being debt-free can reduce stress and give you the freedom to do other things with your money. If you decide that paying off your mortgage is the right decision for you, there are several ways to make it work, even if you’ve got a tight budget. But there are also times when it may make sense for you to do other things with your money.
Here’s what to consider and how to move ahead if you decide that paying off your mortgage early is right for you.
Pros to paying off your mortgage faster
Sometimes, the peace of mind you gain from knowing you don’t have a big mortgage payment to make every month makes it all worthwhile. There are a lot of psychological advantages to being debt free. But there are other benefits as well.
- Saves money on interest. Depending on your mortgage amount, term, and interest rate, an early payoff could end up saving you money—in some cases, a lot of money.
- Builds home equity faster. When you own a larger share of your home, it helps you build your overall wealth. It also gives you the option to tap into that equity later with a home equity loan.
- Frees up cash for other uses. When you’re not making a mortgage payment every month, it’ll leave you with more money to invest or save for retirement, to buy a vacation home or a rental property, to establish a college savings account for your children or grandchildren, or for other uses.
Cons to paying off your mortgage faster
While there are many advantages to doing so, paying off your mortgage early is not the right move for everyone. Here are some of the drawbacks.
- Reduces cash flow. If the extra mortgage payments put the rest of your overall financial situation in jeopardy, early payment may not be for you. Make sure you have three to six months of emergency savings set aside before you begin the process of paying off your mortgage early.
- Makes it more difficult to pay off other debt. Most experts recommend that you pay down the debt with the highest interest before you make other moves. If you have high interest debt like credit card balances or auto loans, you may want to focus your attention on paying these down first.
- Means you miss investment opportunities. If you’re paying more towards your mortgage now, you’ll have less money available for investing, and those investments could result in higher long-term returns than those you earn by paying off your mortgage early.
5 Ways to pay off your mortgage early
If you’ve decided that you want to pay off your mortgage early and you’re certain your mortgage lender has no prepayment penalty, here are five ways you can do it.
1. Increase your monthly payment
This one is straightforward—just commit to pay extra every month. Even if it’s just a small amount—you round up your payment and pay $2,000 a month instead of the required $1,768—it can make a big difference.
For example, let’s say you have a $350,000 mortgage, and you have 18 years remaining on a 30-year term at 6% interest. By paying just an extra $150 each month, your mortgage will be paid off two full years faster.
To decide whether you can afford to increase your monthly payment, first set a budget (if you don’t already have one), and then take a close look at all your expenses to see what you can cut. Monthly subscriptions are a good place to start; so is an unused gym membership, dining out, and other flexible expenses. Once you’ve determined how much extra you can pay each month towards your mortgage, make it automatic. But before you start, talk with your lender to make sure the extra money will go towards paying down your principal, not towards interest.
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2. Make extra payments
This tactic doesn’t cost you any extra money, but it could make a significant difference. By making one small change—keeping your monthly mortgage payment the same but making two half payments each month instead of one full payment—you’ll reduce the total amount you pay over the life of the loan.
For example, let’s say you have a $350,000, 30-year mortgage at 6% interest. By switching to bi-weekly payments, you can pay off your mortgage in 24-1/2 years instead of 30, and the accelerated payments save more than $85,000 in interest.
Other options are to make extra payments when you receive a tax refund or another windfall or make an extra payment on a regular basis—once a quarter, for example.
Again, talk with your lender to make sure they allow extra payments and double check to ensure that the extra money will go towards paying down your principal, not towards interest.
3. Refinance to a shorter term
While the ultimate value of a refinance is determined by market conditions and interest rates, you may want to consider refinancing to a 15-year rather than a 30-year mortgage if the interest rates and payoff schedules make sense. This approach will increase your monthly payments, but you’ll pay off your mortgage faster. Just make sure the breakeven point makes sense for you.
There are costs other than interest rates associated with a refinance, such as closing costs, though, so be sure to include those in your calculations. A mortgage specialist can help you run the numbers to determine if a refinance will help you reach your goals.
Recast your mortgage
This technique, which is different than refinancing, can also help you pay off your mortgage more quickly and it’s a less expensive alternative to refinancing. The idea is to make a single lump sum payment toward your principal; lenders typically want at least $10,000. Your lender will then reset the amortization schedule and give you a new repayment amount. Technically, the process doesn’t shorten your payment schedule or lower your interest rate, it just reduces your required monthly payment amount. But if you stick with your old mortgage payment and then have the extra money go towards principal, the process will help you pay off your mortgage sooner.
Not all mortgage lenders offer recasting and there’s usually a fee associated with it, but it might be a good alternative to a refinance, especially if you have a low interest rate you want to keep.
4. Downsize your home
Have all your kids gone off to college? Has your lifestyle changed so that you no longer need a big house? There are a lot of advantages to downsizing, including a smaller mortgage, lower utility bills and homeowners insurance, and more. If you decide to move to a smaller, less expensive house, consider keeping your payments the same as they were for the bigger house. Or you may be able to afford a shorter 15-year term when you have a smaller mortgage. And if things really go your way, you may even be able to use the proceeds from selling your old home to pay cash for a smaller place and get rid of your mortgage altogether.
5. Invest towards your mortgage payoff
This option carries a bit of risk, but it’s a tactic that you might want to consider. Instead of paying extra towards your mortgage, you could use that money to start an investment account. Because investments can fluctuate up or down in value, there’s always a risk that you could lose money. But there’s also the potential for higher returns on the investment than what you’d typically get by paying off your mortgage. When it makes sense to do so, you can then use those funds to pay off your mortgage.
Tax implications to paying off your mortgage early
Once you’ve paid off your mortgage, you’ll lose the ability to deduct the mortgage interest on your taxes, which means you’ll pay less in interest but more in income taxes. But another thing could also occur—it could also mean it’s more difficult to meet that standard deduction threshold, and you could lose the ability to itemize your deductions and deduct other expenses as well, such as charitable donations above a certain amount. Certainly, life is simpler when you just have the standard deduction but be sure to talk with your tax advisor about how paying off your mortgage early will affect you.
Final thoughts
Do you dream about waking up in a house that’s completely yours? Undoubtedly, there’s peace of mind that comes with not having to make a mortgage payment every month, and you could end up saving a lot of money in the long run when you pay down that debt early.
Certainly, the extra money you put towards paying off your mortgage early means you must give up other things. But for some people, the thought of being mortgage free is worth it, even if the numbers don’t make financial sense. It’s a decision only you can make.
