At first thought, it may seem logical to take any extra money you might have (thank you work bonus!) and pay down your mortgage. Seems like a good idea on the surface, but let’s dive deeper and see if it’s right for YOU.
Tackling mortgage debt on the fast track is not highly recommended unless you are nearing retirement. According to financial experts, there are better things to do with your money.
Let’s put aside the emotional relief of paying off your mortgage and just look at the basic math or purely “financial” side of the situation. Here’s a rundown of five strategies that you should consider before you pay down your mortgage:
1) It won’t change your monthly payment unless you refinance.
Paying down your mortgage will not decrease your monthly housing costs unless you refinance or ask your lender to “recast” your loan, which they are not obligated to do. All it will do is get your loan paid off earlier than 30 years … but if aren’t interested in living in this home for 30 years, then don’t pay down your mortgage!
2) You won’t get “more” out of your home the “more” you pay down your mortgage.
Your home will be worth the same amount when you go to sell whether you pay down your mortgage or not. However, if you put the same money in another investment that you would otherwise have put into paying down your mortgage, THAT money could grow.
In other words, you don’t get “more” back when you pay down your mortgage when you sell your home, you just get your savings account back. And you’ll have many years ahead without access to that money you used to pay down the mortgage until you sell (or refinance), which also include additional costs for those transactions.
3) Put your extra cash where you can touch it.
With so much uncertainty in the economy, having a steady cash flow is essential. Once you put any extra money toward your mortgage, you can’t get it back. Basically, equity in your house isn’t as easily liquidated as having it in your bank account!
You want to have a robust savings that you can turn to for emergencies that will hold you over just in case you lose your job or face an unexpected medical crisis. Most experts advise to have enough cash for at least 6 months’ worth of living expenses, and that should be your first priority.
4) Max out all other parts of your financial portfolio first.
Your home should be just one aspect of your entire financial portfolio. Make sure that you not only have an emergency savings account, but other investments as well so that you are diversified. One example of this is to make sure you are maxing out your retirement plans, especially so you can get that added bonus of a full match from your employer.
5) Pay off higher debt.
If you have the extra money to put toward your mortgage, than consider using it toward other debt first. Paying off higher interest debt, such as credit cards and car loans, rather than a low-rate mortgage, can bring you more financial security.
6) Look for better returns with investments.
Given today’s relatively low mortgage rates, it can make more sense to invest your money elsewhere at perhaps a higher return, such as with stocks or bonds. Historically, if you have a 50/50 stock bond portfolio you can earn a modest 6% return or perhaps 8.2% over the long term. If you’re in the 25% tax bracket, a 5% interest rate may be costing you as little as 3.5% if you itemize.
You can easily get a better return than that with your money if you invest it wisely rather than paying down your mortgage. As always, check in with your tax and financial advisors to see what’s best for YOUR particular situation.
7) Don’t forget the tax break.
The benefit of deducting your mortgage interest is something to keep in mind. This tax break is an added perk that makes it well worth keeping your mortgage around. This is especially true if you’re only a few years into your mortgage and not near retirement age.
8) Determine your homeownership plans.
It doesn’t make sense to put extra money into your mortgage if you plan to move in a few years, whether you’re trading up or downsizing. You don’t know what the market will be like when it’s time to sell and it’s better to have that cash on hand to help purchase a new place. Having cash in your bank and not in your home when you want to move makes buying the new home so much easier!
When SHOULD you pay down your mortgage then?
There are situations where paying down a mortgage does make sense, such as when you’re approaching retirement and you want to be debt-free at that point in your life.
If this is more important to you and your family – to have no monthly mortgage payments entirely, than go ahead and pay down your mortgage earlier. It might not make as much sense financially but if it makes your sleep better at night, then it’s worth it.
You need to answer some important questions to see if and when paying down or paying off your mortgage will be beneficial to you – whether it’s financial or emotional goal.
What is your life like right now and near future?
Depending on your answers, you’ll know if you should be using extra cash toward your mortgage.
- Do you need funds for daycare, commuting or car costs, college saving for kids, family vacations, or other essentials or goals that should take priority now?
- And if this isn’t your forever home, do you need to save for your next home?
- Do you have other higher interest debt you should focus on rather than use extra cash for paying down your mortgage? Car loans, student loans, credit card bills, etc should not be overlooked.
- Is your income stable now and in the long term?
If you have extra cash, no other debt, and maxed out retirement options, then making additional payments on your mortgage could be a good choice if you have a certain date in mind to be debt-free with your home.
What do you see for your life ahead?
Many homeowners as they near retirement might have some peace of mind to own their home outright and not have to still be making loan payments. They don’t want to sell their home and want to stay put and use that extra cash for travel, hobbies or additional health care costs.
Is this you? If so, make sure you haven’t shortchanged your retirement savings over the years and are on track for that before you start to pay down your mortgage. Most financial experts will tell you to focus on your retirement plans or look into other higher yielding options to make the most of your money.
Will this be your forever home?
If you see this home as your forever home, then carefully weigh the pros and cons of putting extra money toward it at some point. You might not be ready now but as you get older and have less expenditures or financial obligations, it could be the right step for you to be debt-free in your home sweet home.
But if this isn’t going to be your forever home, then paying off the mortgage might not be the best decision. You’ve heard the term, “House rich but cash poor.” You want to have your money where you can touch it if you need it.
Remember that your money will be tied up into a home and its equity if you put it toward your mortgage principal. You will no longer have the flexibility to use extra money for any unexpected emergencies or expenditures, plus you could risk losing money if a housing crisis occurs and its value drops. You’ll need to have a clearer picture (or crystal ball!) of your local housing market!
What’s the primary reason you want to pay off your mortgage?
Many homeowners have an underlying reason that they are determined to pay off their mortgage early and live more debt-free. If it’s something that means a lot to you and how you view debt and financial goals, then it’s something to consider and come up with a workable plan.
Two of the main reasons to pay off or down your mortgage are:
1. You hate paying interest and feel strongly about wasting money that way. Most homeowners don’t like paying interest on their mortgage but some really hate this fact and think it’s money down the drain, while others accept that it’s the cost of getting a loan and buying their home.
If saving money on interest is a driving factor for you, then paying down your mortgage could give you the satisfaction you want. Just be sure that putting your extra cash into your home where you can’t touch it won’t become a problem if something unforeseen happens.
2. You want to stop worrying about what will happen to your home when you’re older. For many retirees, the peace of mind of not having mortgage payments wins out. Knowing that you can’t lose your home because of lack of funds or from an unexpected health emergency can ease worries about the future as you get older.
Some homeowners know that their parents did the same thing and had a sense of accomplishment to reach their retirement years this way. If that’s you and you don’t see yourself downsizing to something smaller, then you can work toward this goal when the time is right on your current home.
However, some homeowners sell their current home and use the profit of their sale to buy a smaller home without a loan — that also can achieve both peace of mind when it comes time not to have a mortgage.
Do you understand any tax implications when your mortgage is gone?
Many homeowners think about the benefit of deducting their mortgage interest rate and that can influence them to keep their mortgage. However, this perk isn’t a tax credit and as you near retirement, it may not outweigh other benefits to paying off your mortgage.
Take the time to figure out how your tax situation may or may not be affected when you stop having a mortgage. Work with a financial and tax advisor so that you can better understand if you’ll benefit from not having a mortgage anymore.
Explore your options and start planning ahead
As you can see, there are many questions you need to ask yourself about your financial goals now and in the future.
Paying off your mortgage early or paying it down with extra funds may or may not be the smartest financial move for you.
These are just some things to consider. If you’d like to talk more, email me and we can set up a time to talk. I can also refer you to financials advisors, accountants or loan officers that can help as well.
I'm Brooke Taylor and I love helping first-time homebuyers and sellers make their real estate goals a reality.
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