Should You Pay Off Your Mortgage Early or Refinance?
If you have the savings, or can afford to sell an investment, paying off your mortgage early or making a partial, lump-sum payment might be right for you. Or you might decide that with today’s low interest rates, refinancing is the way to go. Here are some points to consider before you decide.
Q: Can I use a cash out refinance as a strategy for buying a second home?
A: Yes. If you’ve owned your current home for years, it likely has gained value over time and even more so in the current climate of low housing inventory. If you aren’t ready to sell, you could refinance and use the cash out as a down payment on a second home. Keep in mind that with a cash out refinance you are paying off the balance of the original loan plus getting cash out, thereby increasing the amount of the loan, raising your monthly payments and starting over in terms of paying more in interest initially, in addition to paying refinancing transaction costs.
Q: What should I consider when refinancing without taking cash out?
A: The interest expenses during the life of the new loan are additional charges and might pose a hidden cost. So be sure to weigh the reduction in monthly payments you may gain with a lower interest rate versus the overall savings over the life of the loan. Review the terms of your current mortgage to see if there’s a prepayment penalty. In some cases you lender might be willing to waive the repayment if you refinance with the same lender. Also if the number of months it will take to pay on your refinance significantly exceeds the number of payments you had left on your original loan, you could be paying a lot of extra interest when you refinance.
Q: What are the benefits of paying off my mortgage early?
A: Whether your home is worth $1 million or $500,000, you could benefit from paying off your mortgage early. If you eliminate years of paying interest during the life of the loan, it could save you thousands of dollars (depending on the remaining balance) and increase your monthly cash flow.1 Another plus is that you’ll have lower monthly household costs on your primary residence in retirement. If you purchase a second home as a vacation getaway, then you will only be making one mortgage payment. And, if you pay off a condo, then you will primarily pay ongoing HOA fees. Keep in mind that HOA fees can increase annually and are not typically tax deductible.2
When considering paying off a mortgage on a home or condo, make sure that you have enough liquidity for unexpected emergencies and other short-term cash needs. And, make sure you have sufficient retirement savings. And, again, in case there’s a prepayment fee if you pay off your loan early, you’ll want to familiarize yourself with your lender’s prepayment policies.2 And, once your house is paid off, you will be responsible for paying your property taxes and insurance (versus a mortgage lender doing so on your behalf out of an escrow account).3
Q: What are my options if I want to make a significant payment on the loan?
A: Rather than paying off the whole amount, you could choose to make a lump-sum payment on the loan. The benefits of that approach include lowering overall interest costs and building equity. There are two primary ways to make a lump-sum payment on a mortgage. You can refinance as a way to lower the interest rate, in addition to making a large payment against the principal of your loan balance.
Q: What are the advantages of not paying off your mortgage early?
A: A mortgage payment can represent an investment that hopefully you are making at a favorable interest rate, especially in light of recent Federal Reserve interest rate cuts. And, rather than taking money from investments to pay off your mortgage, that money can stay invested, giving it the opportunity to grow tax-deferred. Also, home values typically appreciate at a rate faster than inflation.1 As of November 2020, the U.S. annual inflation rate was just 1.2 percent.4 So, for example, if your $1 million home increased in value by just $30,000, or 3 percent, over the same period then that appreciation would outpace inflation.
Q: What are the tax implications if you don’t pay it off?
A: Keep in mind since the Tax Cuts and Jobs Act of 2017, if you are married and filing jointly the mortgage interest you can deduct on your taxes is any interest on the first $750,000 of qualified residence loans you may have (previously $1 million). If you’re single or married and filing separately, the amount of mortgage interest you can deduct is capped on the first $375,000 of qualified debt (previously $500,000). The remaining mortgage amount receives no tax benefit. However, if you took out a mortgage between Oct. 12, 1987, and Dec. 16, 2017, there are exceptions on the interest you can deduct, so consult with your advisor if you fall into this category.5
While the cap on deductible mortgage interest is substantial for higher market-value homes, remember that mortgage debt is one of the only forms of consumer debt that allows for interest to be tax deductible. For that reason, in the grand scheme of individual debt, it’s much more preferable to have than debt from credit cards, auto loans or other personal loans.
As far as your property taxes, they are based on local tax rates and your property’s assessed value. You could see a rise in property taxes you owe if your home increases in value year-over-year, so budget for potential increases.
Partner With Your Wealth Advisor
Before you make the decision, it’s a good idea to partner with your wealth advisor for a comprehensive look at both your finances and your long-term wealth management plan. At Mariner Wealth Advisors, we can look at your particular situation and offer advice on what might make sense for you.
1“Paying Off Your Mortgage Early: Pros and Cons,” ValuePenguin.
2 “What You Need to Know About HOA Fees,” Mortgage Calculator.
3“Are Property Taxes Included in Mortgage Payments?” smartasset.
4 “United States Inflation Rate,” Trading Economics
5“Home Mortgage Interest Deduction for 2019 Returns,” IRS.
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