Is it wise to pay off your mortgage early? As with most financial decisions, this one depends on several factors including your current mortgage rate, tax bracket, balances on credit card and consumer debt, near-term expenses, retirement dates, and potential alternative investments.
Mortgage prepayment can certainly offer advantages. For example, you’ll pay less interest in the long run. Let’s say you have a 30-year fixed rate mortgage at 7% with a balance of $180,000. By paying an extra $75 per month toward the principal balance, you’ll save about $49,000 in interest and the mortgage will be paid off five years early. Generally, the longer the mortgage term and the higher the interest rate, the more savings you realize by prepaying. Also, because you’re paying off a debt you already owe, the return on mortgage prepayment is risk-free.
But prepaying your mortgage isn’t always the best idea. Do you have large balances on credit cards or high-interest consumer loans? It’s probably a good idea to use extra funds to pay off those debts first. Non-mortgage debt generally carries a higher interest rate, and the interest isn’t tax-deductible.
If your employer matches contributions to your 401(k) retirement account, invest up to the matching limit before putting extra cash into your mortgage. Chances are you’ll net a higher return on your retirement account than by mortgage prepayment.
Consider also whether you’ll need those extra funds for near-term expenses. Money locked up in your home mortgage is much less liquid than in a savings account. It’s harder to get at for college tuition, medical bills, or emergencies.
You may also consider putting that extra monthly payment into other types of investments. Over the long term the stock market has generated about a 10% return. If you have a 6% mortgage and a long time horizon, you may be better advised to put those extra funds into a mutual fund.
Prepaying a mortgage can be a good idea. Just be sure you’ve considered
all the relevant factors.