Thinking to pay off your mortgage early?
Is retiring mortgages early a good idea for a borrower? Doesn’t it sound good to not have to worry about monthly payments for the house you bought? I mean think of all the other things you can put your energy towards.
Yes, it sounds like a good option. However tempting it may be, you must consider the opportunity cost for paying off the loan. For instance, there may be other goals or investment options you are considering. Additionally, it is important to note the impact it would have on your tax situation. In this blog post, I will elaborate on the pros and cons of paying off one’s mortgage early.
Pros and Cons of Retiring Mortgages
Pros
- For starters, retiring a mortgage can significantly reduce stress. People are able to enjoy peace of mind that comes with being debt-free even later in retirement.
- Think of how paying off your mortgage provides an equity cushion that you can use for real emergencies.
- Consider how there is zero market risk to retiring your mortgage early. Additionally, it is also 100 percent safe to do so.
- Focusing on retiring your mortgage prevents you from spending that money on other things, while you reduce that debt. Getting rid of a liability is synonymous to making an investment. By paying it off early, you can save on additional interest expenses that you incur during your regular payments. You’re making the interest back because you aren’t paying it to someone else. If your living expense is lower (due to retiring your mortgage), you can tap into fewer retirement assets. You have access to more money to meet monthly expenses.
- For example, the 5% that you used to pay to the lender becomes the 5% in your pocket. It becomes accessible for you to use in other things. This was just an example. Paying off your mortgage changes cash flow for potential asset allocation. Also, it lowers your required cash flow, thus allowing you to be a little more aggressive. Think of the opportunity cost! Depending on your scenario, your savings can be significant! Your savings can increase with the prepayment amount.
Usually if the aforementioned applies to you, you have usually maxed out your retirement savings. Not only have you set aside an emergency fund, but you also have a sizable chunk of cash available outside of your mortgage payment.
Cons
- Although retiring mortgages doesn’t involve volatility, there are other important liabilities you need to consider. If you have a high credit card debt, it would be a wise decision to pay that off first. Credit card debt in non-deductible!
- There are instances in which focusing on paying off your mortgage prevents you from making potential gains elsewhere. In other words, you can perhaps invest your funds somewhere else. To determine the outcome of this opportunity cost, you can compare the monthly mortgage interest rate to the after-tax rate of return on a low-risk investment (usually with a similar term). If the rate or return on the investment is higher than the interest rate on the mortgage, it would be smart to invest in this opportunity cost.
- Another con of paying off your mortgage early is that you can end up with lower cash reserves. In other words, you have less cash available for general expenses, emergencies, and discretionary spending. It would be smart to keep a cash reserve of a few months to a year in an emergency fund.
- If you’re thinking of moving a the next few years, there really isn’t a point in retiring your mortgage. Downsizing might get you the cash you need to pay off the mortgage. Also, if you decide to downsize, you will not have to tap your savings.
- If you are behind on your retirement savings, it is highly advised that this be the first step. Contribute the maximum amount to your retirement accounts such as the 401(k) or IRA. Savings in these types of accounts have a chance to grow without taxes. The growth stops however when you withdraw your savings.
Final Thoughts
The monthly mortgage payment usually makes up the single largest cost the average consumer faces. It accounts for 50% of the consumer’s net income. Additionally, it accounts for 30% or more of the consumer’s gross income. In other words, retiring mortgages is not something that the borrower can think up overnight. Furthermore, it is important to think it through.
You should earmark your income for what you prioritize. You can be a risk taker or someone who wants to play it safe. Either way, you can get advice from a financial planner. The planner can help you better understand the decision to take. You can see how paying off your mortgage fits in with the rest of your financial plans. You can consider using a mortgage payoff calculator. This nifty tool can help you calculate what is best to do in your particular situation. At the end of the day, you need to decide if this option is best for you.
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