Is Paying off Your Mortgage Early Beneficial
Is Paying off Your Mortgage Early Beneficial?
The mere idea of paying off your mortgage early may sound scary, and even unnecessary. However, if you are a current homeowner, who has been making monthly mortgage payments over the past 7, 10, or even 15 years, you may begin to wonder if paying off your mortgage early is beneficial?
The best answer will truly depend on what your goal is and how long you have owned the home, as these two factors will directly affect whether ditching the mortgage early is worth it.
Why would you pay off your mortgage early?
Many homeowners are drawn to the idea of paying their mortgage off early to save on interest. Typically, the total interest paid over the life of a home loan can range anywhere from $180,000 or more, on top of the purchase price. In theory, by eliminating the mortgage early, you can save a lot of money.
Additionally, many homeowners simply like the feeling of owning their home free and clear. Getting rid of such as large debt can bring a certain peace of mind. Furthermore, homeowners preparing for retirement may simply not want to deal with a hefty mortgage payment on a fixed income.
Lastly, a handful of homeowners see it as a necessary step in order to be eligible for home equity lines of credit or reverse mortgages. Should there be a financial emergency, they want the option to access their home’s equity, without a current mortgage standing in their way.
Save Little Interest
When you make your monthly mortgage payment, you are actually paying for two things: the principal balance and the interest on the loan. For example, if you bought a home for $300,000 and are paying 3.5% interest, part of your $1,347.13 mortgage payment is paying down the $300,000 you owe, while the other part is paying the interest on the remaining balance.
(Below is an example summary of this mortgage. Interest paid over time is yellow, and the balance paid over time is green. )
As you can see, however, over time, the percentage of your mortgage that is paid towards interest, while the percentage of each payment paid towards the balance, increases. Therefore, if you pay off your mortgage in year 20, it may be the case that you’re only saving a couple thousand dollars of interest.
A Home is Not an ATM
Additionally, no matter how much equity you have in your home, real estate is not a liquid asset, meaning it is not like an ATM. It takes time, sometimes months, to actually convert the value of your home into cash in hand.
Therefore, while you may be able to put $200,000 cash into your home to pay off the mortgage early, it will usually take much longer to get that exact amount back.
Along those same lines, if the market fluctuates too much, it may be the case that you may never be able to pull the same amount of equity you put into your by paying it off. During the last Great Recession this happened to many homeowners in Florida. They paid off their $400,000 house early, eager to cash in on rising prices, but when the market tanked, their homes dropped to as little as $250,000. That’s $150,000 they will never see again.
Lastly, when it comes to paying off your mortgage too early you may be subject to prepayment penalties. A prepayment penalty is essentially a fee a borrower pays a lender when they decide to pay off the entire loan or make sizeable monthly payments. Since the passage of the Dodd-Frank Act in 2010, these are typically limited to 2% of the loan balance in the first two years followed by 1% in the 3rd year.
What are Your Alternatives?
In my humble opinion, if you are a homeowner in a position to pay off your mortgage early, consider the following, more financially beneficial, options instead:
• Buy a second property to take advantage of historic low interest rates. Rather than pay off your mortgage to save maybe 4-5% on interest, invest it in an income generating property, like a rental home or apartment. Buying an investment at 3% interest that generates a 10% return will be a much better use of the money in the long run.
• Pay off debt with higher interest rates, such as credit cards, car loans, or even any personal loans. It may seem counterintuitive, but if your goal is to use the money to save on interest, these items have much higher interest rates, some as high as 25% APR.
• Refinance your current mortgage, so that the monthly payments are smaller and more manageable. I said it before and I will say it again, interest rates are so low; the lowest they’ve been in years. If your goal is to eliminate your debt as quickly as possible, consider refinancing into a 15-year loan where the payments may be the same or slightly higher, but you will be able to pay off your home loan in half the time.
If you are in a position to pay off your mortgage early first off congratulations. Getting to this point is not easy, and it only gets harder as you now have to figure how to use it wisely. There are many paths to build equity in real estate, and I can help you find the one ideal for you and your family.
Cindy Lee 904-803-3141
Author: Cindy Lee
December 28th 2019
About Cindy: If you are looking for a real estate professional who is passionate about her work, experienced, con...