The Pros and Cons of Paying Off Your Mortgage Early
Most people dream about the day they finally pay off their mortgage. After years and years of monthly payments, it feels pretty good to sign that last check.
So, you’d think that paying off your mortgage early would make sense, right? If you’re a physician with a hefty monthly salary, wouldn’t you want to pay it off ASAP?
Well, not necessarily.
If you have the means, it’s tempting to pay off your debts in one lump sum and stop worrying about monthly payments.
However, paying a lump sum (or a series of lump sums) isn’t always the way to go. In fact, it might even be detrimental to your finances. Depending on your situation, it may or may not be a good option for you.
In this article, we’ll discuss the pros and cons of paying off your mortgage early.
Not sure if this is the right move? Keep reading to learn more.
The Benefits of Paying Off Your Mortgage Early
There are several reasons to pay off your mortgage as soon as possible. Here are a few of the most significant benefits:
#1 You Can Live Debt-Free
You can never underestimate the satisfaction that comes with paying off a loan. It feels extraordinarily good to go to sleep at night knowing that you don’t owe the bank a dime.
This is one of the main reasons why people choose to pay off their mortgage early.
For some people, their mortgage is their most significant source of debt. For others, it’s their only source of debt. So, paying off a home loan can relieve you of a substantial financial burden.
#2 You Will Pay Less Interest
Once you pay off your mortgage, it stops accumulating interest. By paying it off today, you’ll avoid paying a more significant amount in the future.
Depending on the price of your home and how much you still owe, this can save you tens of thousands of dollars.
And, you don’t have to worry about missing payments in the case of an emergency. Even if you lose your job, you won’t have to worry. While you’ll still have to pay property taxes, your interest won’t build up.
#3 You’ll Pay Off Your PMI
Many homeowners pay private mortgage insurance (PMI) on their loans. Typically, it’s an annual payment equal to .5% to 1% of the full loan amount. This is one way that banks protect themselves from defaulted loans.
You only have to pay PMI until you have a 20% equity stake in the property. In other words, once you’ve paid 20% of the entire loan (not including interest), you can cancel the insurance.
If you pay for the entire house in one or two lump sums, you don’t have to worry about the added cost of insurance.
#4 You Have More Cash for Other Investments
In the United States, the average monthly mortgage payment is around $1,022. So, it’s likely that you’re giving the bank at least a grand every month for your home.
Imagine what it’d feel like to have an extra thousand dollars every month? There’s probably a laundry list of other things you’d like to spend that money on!
Maybe you want to put that money toward another property you’ve had your eye on. Perhaps you’d like to give your children some college tuition money. Or, you might even want to invest that money into the stock market.
Truthfully, the best option might be to take that money and invest it elsewhere. By putting it into another investment, you could yield more return on your income.
The Disadvantages of Paying Off Your Mortgage Early
The psychological benefits of paying off your home are great. But, there are a few downsides, too.
#1 You Might Eliminate Your Savings
If you have to tap into your savings, don’t do it. That is not the best use of your money.
It’s much better to have a safety net of cash and liquid assets on hand. Spending your savings could put you in a position where you need to borrow from your home’s equity for emergencies.
#2 You’ll Lose Out on Tax Deductions
There aren’t any tax advantages associated with paying your mortgage off. But, you do get tax benefits when you continue to make payments. The IRS allows you to deduct interest payments on up to $750k of your mortgage debt.
Once your mortgage is paid off, you’ll no longer be able to deduct that interest from your taxes. For many individuals, that deduction makes a considerable difference in their year-end tax payments.
#3 You Could Lose Equity
Home equity is only valuable when the market is good. If the housing market is not healthy, paying off your mortgage early could actually cause you to lose equity in your home.
After all, a home isn’t exactly a liquid asset if you can’t sell it, right?
This poses a real problem for many homeowners. It will put you in a difficult situation if you plan to sell your home for retirement money or emergency expenses.
If you save that money instead of putting it toward your home loan, however, you’ll have a nice retirement nest-egg.
#4 You Might Miss Out on Other Investment Opportunities
If you have the means to pay off your mortgage, consider putting your money into other investments instead.
Typically, mortgage interest rates are quite low. Rather than save yourself from a 3% or 4% mortgage interest rate, you could invest that money in areas that will net you more gains in the long run.
For example, you could use that extra cash to invest in more real estate. As a physician, you might even invest it in a commercial property for your private practice.
Or you might consider investing your extra money in the stock market. As of today, the average interest rate on a 30-year mortgage is 4.125%. Even on a 15-year mortgage, interest accumulates at around 3.5%.
Stock market returns, on the other hand, increase by an average of 10% annually. In other words, you could get a better return by investing your money instead of spending it.
Assuming that your mortgage balance and stock investments are about equal, earning 10% is better than spending 4%.
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People Who Should Not Pay Their Mortgages Early
There are many apparent benefits to paying off your mortgage early. However, they don’t work for everyone.
These people should not consider paying their mortgage off yet:
People with Other Significant Debts
If you have other debts with higher interest rates, don’t worry about paying off your mortgage right now. Pay off your school loans, car loan, and credit card debts before you cut the final check to your mortgage lender.
Home equity lines of credit also carry higher interest rates than mortgages, so it’s always best to eradicate that type of debt first.
In fact, mortgages are often referred to as “good debt.” Your home is an investment. Depending on the real estate market, many people turn a profit by selling their home for more than they paid for it.
Unfortunately, you can’t say the same for credit card debt or super high-interest student loans. Identify your debts with the highest interest rates and pay these off first. There is really no benefit to carrying a balance on a credit card or other high-interest rate loans.
People with Loan Prepayment Penalties
Prepayment penalties are banned in most states. However, some states still allow lenders to include a penalty clause to prevent homeowners from paying it off early.
In other words, some people are required by contract to stick it out for the entire loan term. If they breach the agreement, they receive a fine. Some prepayment penalty fines are very high (equal to 80% of six months interest!).
If you’ll be penalized for paying your mortgage off, it’s clearly a bad idea. Continue making payments each month until the penalty expires. There’s no good reason to incur those fees.
People with No Savings
Paying off your mortgage with a lump sum is a luxury. It’s not a necessity. It’s more important to have money in your savings account for emergencies.
Do you have an emergency fund? If not, build one before you spend your cash to pay off that mortgage.
When determining how much to save in your emergency fund, total up your monthly bills and expenses. A healthy emergency fund should be able to carry you for a minimum of 12 months in case of a job loss, disability, or other hardship.
If you don’t have enough money to survive for a year without income, don’t worry about paying off your home loan right now.
Paying Off Your Mortgage Faster (Without Paying it Off Completely)
If your mortgage is stressing you out or preventing you from living a debt-free life, then it may be worth it to pay it off early. But for most people, that’s not necessarily the case.
If you have excessive debt or a lack of savings, it’s not the right choice for you.
But, there are still a few options that can make your life easier:
Rather than paying 100% of your mortgage off, consider ways to pay it off faster. Instead of canceling it with one lump sum, you can eliminate some of the psychological burdens by speeding up the payment process.
With a 30-year loan, it can feel like you’re tied to that mortgage for eternity. But if you refinance to a shorter term loan, you can turn it into a 10, 15, or 20-year mortgage.
This option not only helps to ease debt anxiety. It also saves you money because most short-term loans come with lower interest rates. This is an excellent option if you have the means to make higher monthly payments.
If you don’t want to refinance, you could start making one extra payment every year. The faster you bring down that balance, the less money you’ll spend in interest.
Do you need help mapping out your future? Learn more about our financial planning services!
As a physician with a high yearly income, it’s tempting to pay off that mortgage and live debt-free. But that’s not always the best decision for your bank account. Like every other big decision in life, paying off your mortgage early comes with its fair share of pros and cons.
Maybe you’re looking for peace of mind as you near retirement. Perhaps you don’t want to waste any more money on interest. Or, maybe you’re just looking to eradicate that monthly bill to free up some future liquid cash.
Whatever the case, canceling your mortgage debt is not a bad thing. But if you want to build wealth for retirement, it’s not the best way to go.
Before you make any commitments, do some serious calculations. Look at your savings, consider your financial goals, and decide where your money is best put to use.
You may find that you’re better off making other investments. You may decide that living debt free is the way you want to go. Either way, the choice is yours.