How to Pay Off a Mortgage Early

A mortgage may be the most positive kind of debt to have, but it’s still debt. Even worse, it’s debt secured by the house where you and your family live. All it takes is a single hardship like a job loss, death of a spouse or an accident that results in disability, and you may be at risk of losing your home. For this reason, some homeowners want to pay off their mortgages early. Others like the freedom of not having a mortgage payment so they can use the money to invest, pursue other interests or retire early.

There’s no single right way to pay off mortgage debt. Like every other decision you make regarding your personal finances, it depends on your short- and long-term goals for your money. Before you make the decision to pay off your mortgage, think carefully about how it changes your life. Consider your answers to following questions:

  • Are you comfortable with debt?
  • What is the value of your home?
  • What else can you do with the money?
  • Would investing make much more money over time?
  • What might you give up by paying off the mortgage early?

Your answers can help you decide if this is the right decision for you. If the thought of having any type of debt bothers you, pay off your mortgage so you can sleep at night. On the other hand, if giving up the mortgage eliminates a hefty tax break or financial aid opportunities for your child’s college education, keeping the mortgage makes more sense. Take a look at a few ways to pay off your mortgage early and how the decision may affect your life to determine if this is the right financial path for your needs.

Should You Pay Off Your Mortgage?

The decision to pay off your mortgage early is a complex one. At first glance, getting rid of this debt seems like a responsible decision that puts more money in your pocket. When you take a closer look, you might see that this may not be the case. For example, it’s probably a smart choice to pay off all of your other debt first. Your credit card debt often comes with high interest rates that may cost you more in the long run. Your student loans and car loans also carry interest rates greater than your mortgage, and they’re for much smaller amounts of money, so you may want to get them out of the way before you tackle the mortgage.

Furthermore, in your haste to pay off your mortgage, you may miss out on opportunities to make more money in the long run. For example, if your employer matches your 401(k) contributions, you may want to take advantage of that and pay more into your 401(k) instead of toward your mortgage. The employer match is money that can bolster your retirement account and give you a better return on your investment if your mortgage interest rate is low enough. Unless you’re near the end of your loan term or close to retirement age, you can put your extra money into retirement funds and enjoy tax-deferred growth.

When Should You Pay Off Your Mortgage Early?

If you’ve already decided it’s in your best interest to pay off your mortgage early, you need to decide the right time to do it. The most important consideration is the amount of money you have left after you make the final payment. Ideally, you want to make sure you have enough money to give yourself a cushion for unexpected expenses without touching your retirement accounts. Some financial planners suggest a one-third rule. That means you should pay off your mortgage if you can do so and use only one-third of your savings, not including your 401(k) or IRA funds.

Pay a Mortgage with a Credit Card

When you receive an offer from a credit card company advertising a 0% interest rate on balance transfers for a specified introductory period of time, you may feel the temptation to use the card to pay off your mortgage. This option can work for you if you qualify for an amount large enough to cover the mortgage balance and can transfer money from the credit card directly to a bank account. You also have to be disciplined with your money and pay down the credit card debt as soon as possible, especially if the interest rate jumps at the end of introductory period.

For many people, this is not a good idea. The interest rate doesn’t stay at 0% for long, and the card issuer can raise your interest rate if you miss a payment. This can damage your credit, making it more difficult to get a loan with decent terms later. You also need to read the conditions of the offer and make sure transfers qualify for the reduced interest rate. Some cards only allow new purchases for the special rate.

How to Pay Off a Mortgage Early

There really is only one way to pay off your mortgage early. You have to give the bank all the money you borrowed plus the accrued interest. The fastest way to do this is pay the bank a lump sum, but you need the full amount in cash. Chances are that, unless you suddenly come into an inheritance, you might not have enough funds liquid in your bank account to make this happen.

Cashing Out Retirement Funds

Some people consider cashing out a retirement account to pay off their mortgage, but there’s no consensus among financial experts to indicate whether this is a smart idea or not. The problem with deducting large sums of money from your retirement accounts is that the IRS views the money as income. This can lead to a surprise when you go to file your taxes and discover that you’re in a new tax bracket thanks to the withdrawal.

When you take money from your retirement accounts, you also reduce the amount of money you have available when you later retire. This is fine for some people who prefer reducing their retirement expenses by eliminating all debt. Just keep in mind that it doesn’t make sense to get rid of a mortgage only to worry about how you can pay for electricity or food during your retirement years.

How to Pay Off a Mortgage Faster

If you don’t have the cash on hand to completely pay off your mortgage, you can pay it off faster than the 15 or 30 years the lender gives you. You just have to pay more than your monthly payment. Review your budget to determine how much more you can pay, and add that to your payment. When you get your tax return, apply the full amount to your loan. Your lender should apply the extra money to your principal to reduce the amount you have left to pay. This adds up to significant savings over the life of the loan.

You can also pay off your mortgage faster without making extra payments — in a way. To do this, switch to a bi-weekly payment plan. For example, instead of paying $1,013 each month, divide the payment into two payments of $506.69. By doing this, you pay off the mortgage four years early and pay nothing more than the original payment amount. Some banks offer this service for an additional fee, but paying this fee cuts into the amount of money you save when you follow a bi-weekly payment plan.

Another option is to refinance your loan with a shorter term. This option only works if your mortgage is still relatively new. For example, if you’re 5 years into a 30-year loan and decide to refinance to a 15-year mortgage, you may finish making payments 10 years earlier than if you stayed with the 30-year loan. On the other hand, if you’re 20 years into a 30-year loan, switching to a 15-year mortgage doesn’t make as much sense. If you only make your regular mortgage payment, you end up paying for a total of 35 years.

Pay Off a Mortgage or Invest?

If you come into an inheritance or receive a significant salary increase, you may wonder if you should use the money to pay off the mortgage or invest it. The answer to this question depends on several factors, including the following:

  • Your tax rate
  • Your credit history
  • Your risk tolerance
  • Your ability to save
  • Your investment allocation

Many people believe mortgage debt is the most helpful kind of debt to have, especially because the interest on the loan is tax deductible and you’re building equity. However, the tax savings are negligible for all but those with high income and property values. Most people see more savings when they choose the IRS’s standard deduction instead of itemizing, so don’t hold onto a mortgage for tax benefits you don’t take.

If you have a poor credit history due to outstanding debts, it makes more sense to pay off consumer debt with high interest rates first. Not only can you focus your attention on your mortgage and investments after getting rid of the more expensive debt, but you also have more money with which to do both.

A poor credit history indicates difficulty managing debt and saving money. Paying your mortgage forces you to save money. As your principal decreases, the equity in your home increases. You can later cash in the equity by selling the house or securing a loan. If you choose to pay your mortgage off early, you need the discipline necessary to save money so you have it when you need it.

One final consideration is your risk tolerance. Paying off your mortgage isn’t too risky, but investments are unreliable. Financial planners who recommend investments over mortgage payments base their advice on investment returns greater than your mortgage interest, especially if you have an aggressive portfolio with the potential to earn a considerable amount of money. Of course, the stock market has the potential to yield more, but there’s no guarantee that it might perform like you expect. In fact, you can lose everything.

How Long to Pay Off a Mortgage?

To figure out how long it can take you to pay off your mortgage, look at the terms of your loan. If you have a 15-year loan and make only your regularly scheduled payments each month, it takes 15 years to pay off the loan. You can shorten this by making additional payments. To determine how quickly you can pay off your mortgage and the amount of money you can save by doing so, enter your information in a mortgage payoff calculator. As an example, here’s what you can save if you’re 5 years into 30-year mortgage for $200,000 at 4.5% interest.

  • Pay an extra $100 each month, and you pay off the original loan 3 years and 9 months early, saving more than $20,000 in interest
  • Increase the extra payment to $200 more, and you pay off the loan 6 years and 6 months earlier and save more than $35,000 in interest
  • With one extra payment each year, you pay off the loan 3 years and 4 months early, saving more than $18,000 in interest
  • If you make a single additional payment of $10,000, you pay off the loan 2 years and 4 months early and see a savings of more than $19,000 in interest

Compare these numbers with what you can make in an investment. If the investment yields more than the amount of interest you can save if you make the extra payments, you may want to place the money in an investment product instead. Conversely, if your interest savings from an early mortgage payoff are greater than your potential investment earnings, use your money to pay off the mortgage.

Conclusion

If you think the decision to pay off your mortgage early is a good plan for you, take the time to investigate the advantages and disadvantages of doing so. Use a mortgage payoff calculator to get an idea of how much you can save, and compare the savings with what you can safely expect to earn if you put the same amount of money in a retirement fund. Consider speaking with a tax professional or financial advisor to determine the most ideal place to put your money. They can help you explore your options and make the decision that’s right for your future.

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Published September 8, 2016
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