Should You Pay Off Your Mortgage Early?
Should you pay off your mortgage early?
If you have the funds, it's tempting, but should you?
Pros: Let's start with the good stuff
You'll Save on Interest
A mortgage is likely the largest loan you will ever take out. Over the course of a 30-year mortgage, you'll be paying a significant sum in interest. By paying off your mortgage early, you'll be able to save on some of that interest. If you'd like to get an idea of how much interest you can save by paying off your loan early, take a look at an amortization calculator like this one.
You'll Free up Funds
With your mortgage payment out of your budget, you will free up some cash that can be used to further your financial stability. You can put this extra money towards your 401K, or pay down your other debts such as high-interest credit cards or auto loans.
Note that if you have high-interest credit cards, these should be paid off before you tackle paying down your lower-interest mortgage.
Read more: Mortgage Basics: Understanding The Terminology Of Buying A Home
There are Psychological Benefits
There are definite psychological benefits to paying off your mortgage. It feels good to be debt-free, or significantly reduce your debt load. For some, sleep comes a little easier when their mortgage is paid off and they own their home outright.
Paying off your mortgage can reduce your financial stress, and less stress leads to better overall health. In fact, it has been shown that paying off debt has a direct effect on self-esteem and general well-being.
You'll Stop Paying PMI
Private Mortgage Insurance may have been required by your lender if your down payment is less than 20 percent of your home's purchase price. PMI protects the lender, not you, against losses if you default on your mortgage. When you pay enough of your mortgage and you have 80% of your home's equity, you can have PMI removed from your mortgage. Of course, paying off your loan entirely eliminates any PMI payments as well.
Cons: Or stuff you need to think about first
Loss of liquidity
If you have the funds available to pay off your mortgage then you will essentially be giving up the use and liquidity of this cash by putting it into your home. That money will be harder to extract for other purposes if you decide you need it or want to invest in something else. A HELOC (Home Equity Line of Credit) can help you gain access to those funds, but you will be, once again, paying interest on any funds you use in your HELOC.
Establishing a HELOC
A Home Equity Line Of Credit or HELOC is a type of loan that you can take out against the value of your home. These accounts are handy to have should you need access to money quickly, say, for a home repair after a storm. If you have paid off your home or have a significant amount of equity in it, you can set up a HELOC so that you are able to liquidate some of the funds against your house when needed. This line of credit can be used for anything that you desire, however, it is best used only for emergencies or if you have a reasonable plan for paying the money back. You have worked hard to increase the equity in your home, use your HELOC wisely so as to not find yourself with a significant loan against the value of your home again.
Read more: What Is Pre-Purchase Housing Counseling?
You still need an emergency fund
If you're looking at a significant amount of savings in your bank account and weighing the value of paying off your mortgage or investing elsewhere, consider that you still need to have an emergency fund available for a rainy day. Make sure your emergency fund is in a separate account and available when you need it. Don't be tempted to pay off your mortgage at the expense of your emergency fund. Save a little longer so that you can both pay off your mortgage and be financially prepared for that rainy day.
Your extra money could go directly into your 401K
Before committing to paying off or down your mortgage, consider the interest rate that you're paying compared to the interest that you could be earning in other investments or that tax break you'll receive if your money is put into your 401K or IRA.
For example, if your mortgage interest rate is 3.5% and your mutual fund investment is earning 7%, you may be better off, in the long run, putting your funds into the mutual fund where you will earn more interest than you are paying on your mortgage. The same goes for the rate of return you are receiving in your retirement account, how does it stack up compared to the costs of keeping your mortgage?
I've paid off my mortgage, what now?
Remember to pay your insurance and property taxes. Generally, home insurance and property taxes are rolled into your mortgage payment. If that's the case, your mortgage company will not be paying them for you any longer. Remember to make these payments when they become due, even better, set up automatic payments and set reminders in your calendar.
Cancel your automatic mortgage payments while you're at it too! If your mortgage payment was leaving your bank account each month automatically, don't forget to turn that off. Enjoy letting that payment accumulate in your bank account from now on.
Ways to pay down your mortgage faster
If you're not ready to pay off your mortgage just yet but want to pay it down a little faster, consider the following methods. You may also need to check that there is no early payoff penalty. Sometimes this penalty is just for the first few years of the loan and diminishes over the first 5 years. It's worth checking if this penalty is associated with the loan.
- • Pay half your mortgage payment every 2 weeks instead of every month. Twelve months equals twelve payments, however, 52 weeks divided by 2 is 26 payments. That's an extra month's worth of mortgage payment every year.
- • Another way to pay an extra payment each year is to divide your mortgage payment by 12 and add that amount on to your regular payment. Over the course of the year you will have paid a 13th payment.
- • Round up the amount you pay with any extra funds you can spare. Add an extra $50 or $100 to your regular payment. These small but consistent extra amounts will have an impact over time.
- • Send any bonus or spare money in the direction of your mortgage. Did you get a bonus at work? Pretend you didn't, and send it straight over to your mortgage. The more you pay down your principal, the less interest you'll be paying over time. Partial lump sum payments push the interest to principal ratio in your favor.
- • Refinance for a lower interest rate. If your interest is significantly higher than what is currently on offer, you may be able to refinance for a lower rate. Just be aware that the 30 or 15 year time will be set back at zero. Your payment will be less, but the math can work out in your favor if you can continue to pay the same amount your were previously paying.
Lori Stratford is the Digital Media Manager at Navicore Solutions. She promotes the reach of Navicore's financial education to the public through social media and blog content.
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