Should You Pay Off Your Mortgage Early?
If you have enough savings, or can afford to sell an investment, paying off your mortgage early or making a partial, lump-sum payment may be in your best interest. Or, you might decide that building equity in your home is the way to go.
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. Keep in mind that some lenders may charge a prepayment fee if you pay off your loan early, so familiarize yourself with your lender’s prepayment policies.1 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. A second, lesser-known strategy is called mortgage recasting. If your mortgage lender will allow it (not all do), you can make a large, lump-sum payment (usually a minimum of $5,000) toward the loan principal. The lender will then amortize the remaining balance to reduce your monthly payment. The lender typically charges a fee for the recasting, which doesn’t usually exceed a few hundred dollars. Recasting means you’ll pay less interest over the life of the loan. Keep in mind, the length of your loan term and your interest rate stay the same, you just reduce the amount you pay each month. In a low interest rate environment, this option may not make sense.4
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 August 2019 , the U.S. annual inflation rate was just 1.7 percent.5 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, with the recent tax law changes, if you are married and filing jointly the mortgage interest you can deduct on your taxes has been reduced to 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.6
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 holistic look at both your finances and your long-term wealth management plan.
1“Paying Off Your Mortgage Early: Pros and Cons,” ValuePenguin. https://bit.ly/2mtpQBD
2Mortgage Calculator. https://bit.ly/2kshhpQ
3“Are Property Taxes Included in Mortgage Payments?” smartasset. https://bit.ly/2lYLCwO
4 “How Mortgage Recasting Works,” Bankrate. https://bit.ly/2BQeNbS
5United States Inflation Rate, Trading Economics. https://bit.ly/2xvEiZA
6Home Mortgage Interest Deduction. IRS. https://bit.ly/1PR0pAr