For many Americans, a mortgage payment constitutes a significant percentage of their monthly expenses. Owning a home has many advantages, but, understandably, homeowners may jump at the chance to pay off their home loan before it’s fully amortized.
Why Pay Off a Mortgage Early?
Paying off a mortgage reduces monthly expenses, has the potential to save you thousands of dollars in interest, and allows you to use your home equity for other loans down the road if needed. However, it’s not the right decision for every homeowner — it depends on your current financial situation, the terms of your loan, and even how close you are to retirement.
For example, homeowners with a low interest rate may find investing their extra money each month provides the possibility for a higher return. If your home loan interest rate is 3%, but you can generate a 5% return through a high-yield savings account, you may consider placing that “extra payment” into savings instead.
The stock market offers potential for returns that can outpace or lag both the figures above. Individual risk tolerance comes into play. Investing instead of paying off a mortgage could bring gains or losses — there’s no way to know for certain.
For those who prefer carrying less debt, paying off a mortgage early would be safer. For those who can tolerate having debt while seeking a potentially higher rate of return on their funds, investing those funds could be the better choice.
How to Pay Off Your Mortgage Early
Every time you make your monthly mortgage payment, a percentage goes toward the principal, the money you borrowed from your lending institution. A percentage of your payment also goes toward the interest accrued on your loan. Paying off a mortgage early is an appealing option to those who want to save on the amount of interest paid over the life of the loan.
You can pay off your mortgage early using several different methods. Each may appeal to homeowners, depending on their preferences and financial situations.
Making Extra Mortgage Payments Over Time
A common strategy to pay off a mortgage early is by making extra payments over time. Typically, this is done by making biweekly payments instead of monthly. By splitting your monthly payment in two, and then making that payment every two weeks, this effectively puts you on track to make the equivalent of thirteen monthly mortgage payments per year instead of twelve. Homeowners can also choose to tack on an additional amount to their minimum payment each month as they’re able. These steps can lead to significant savings over time.
It’s important to note that homeowners should allocate any additional payments to the principal of their loan. This lowers the amount of the loan that accrues interest allowing the loan to be paid off earlier than originally scheduled.
Refinancing Your Mortgage Into a Shorter Loan Term
If your financial situation has improved since you bought your home, you may want to refinance your mortgage with a shorter loan term. Perhaps you got a significant promotion at work, and are earning incomes from both spouses, or paid off other debts and have more money to contribute monthly.
If you originally had a 30-year loan term and are 5 years in, you could refinance into a 15-year loan and pay off your home 10 years sooner than planned. Typically, this new loan will come with lower interest rates as compared to a 30-year loan, higher monthly payments, and refinancing costs. However, you’ll pay much less interest over the term of the mortgage. If this method is of interest, it will help to discuss refinancing and its implications for your budget with your financial advisor to decide if it’s a wise choice for you.
Paying Off Your Mortgage With a Lump Sum
While it’s less common than the previous two options, some homeowners experience an event, such as an inheritance or settlement, that provides a lump sum of money. Others may have accumulated enough savings to a point where a portion could be used to pay off their home loan for good. Talk to your financial advisor about these options as they may include tax implications and impact your portfolio objectives.
5 Questions to Ask Yourself Before Paying Off Your Mortgage
If you’re considering paying off your mortgage early, it’s important to consider discussing these five issues with your financial advisor if applicable.
What are my other savings goals?
You may also have additional savings goals you want to prioritize. Perhaps you want to maximize your IRA for the year before adding an extra payment to your mortgage, or you want to devote all extra funds to your child’s 529 plan. Saving for retirement and education are important goals, and you may benefit from investing in those accounts instead of shaving a few years off your mortgage.
Will I face a prepayment penalty?
Before planning to pay off your mortgage early, check with your lender to ensure you won’t be penalized. Many loans have mortgage prepayment penalties that go away after the first several years, but you’ll need to confirm.
Have I paid off higher-interest debts?
A mortgage is often the largest debt individuals take on. However, other debts can come with much higher interest rates. If you have a 4.5% mortgage interest rate, but you’re also making payments to a student loan with 8% interest or a credit card with 18% interest, you should pay off those debts first.
Do I have liquid assets available?
Before supplementing your mortgage payments with additional funds, you may want to pad your emergency fund, sinking fund, or savings account with extra cash.
Unexpected expenses pop up for all of us at some point, and it’s important to put away enough money to live on in case of an emergency, along with a fund to repair and update your home as needed over time.
Your home is considered an illiquid asset since it takes time to list and sell, so paying off your mortgage early will not benefit you if you’re left without liquidity to cover expenses and emergencies.
If I don’t pay off my mortgage early, how will I use my money?
Some of us need a plan in place for every dollar to avoid unwise spending. Without a solid financial plan, unbudgeted money may go to waste. If this is the case, paying off your mortgage early may be a wise investment in your future. Work with your financial advisor to determine a budget that works for you.
Helping You Find Financial Freedom
Whether considering paying your home loan early, managing your investments, or building a personal finance strategy that works for you, Marietta Wealth is here to help you achieve your goals and find financial freedom.
Our financial advisors build personalized financial plans for every client, and our fee-only model guarantees that our only incentive is giving you peace of mind. If you’re looking for an advisory firm in Georgia you can trust, give us a call today and discover the Marietta difference.
Marietta Wealth is a registered investment adviser. Registration of an investment adviser does not imply any level of skill or training. For additional information about Marietta Wealth’s financial planning and advisory services, please see the Marietta Wealth Disclosure Brochure or ADV Part 2A for full details, which is available upon request or by visiting our website.
This article is not intended to be used, and should not be used, as the sole basis for legal advice. The reader should seek and rely upon the guidance and advice of legal counsel before making decisions regarding any estate planning tools or documents.