Should You Pay Off Your Mortgage Early or Save? Here's How to Decide, According to Financial Experts
They’re both good options, but experts explain how to choose one over the other.
If you're in a position to pay off your mortgage, first give yourself a huge pat on the back—that's a major accomplishment. Paying off your mortgage early has a number of benefits, such as having fewer monthly payments, so you can put more of your money toward retirement or another one of your financial goals; what's more, you might save what could be thousands of dollars or more on interest, says Andy Taylor, vice president and general manager at Credit Karma. And when you pay off your mortgage, you own your home outright, so if you're faced with an unexpected financial hardship like a job loss or medical crisis, you have peace of mind that you won't lose your home as a result.
Sounds pretty good, right? Before putting pen to paper and signing that check, Taylor says there are a few trade-offs to be aware of. First, investing pays better, he says. "Sometimes, you're better off taking the money you would have used to pay off your home loan and investing it, but it depends on the relative rate of return." In layman's terms: If your mortgage interest rate is three percent, but you could earn five percent somewhere else (like the stock market), it might make sense to invest that money instead. Second, you'll no longer receive a mortgage interest tax deduction, Taylor explains. "Homeowners can take advantage of certain federal income tax breaks, including a mortgage interest deduction." This perk allows homeowners to claim the amount they pay in home loan interest to lower their overall taxable income each year.
And finally, when you pay off your mortgage, chances are you're writing a pretty hefty check. This type of spending is called "liquidity loss," and refers to your ability to access and spend your funds, explains Taylor. "Consumers who pay off their mortgage should consider that if an emergency arises and they need cash, will they still have funds sitting in their investment or banking account that they can tap into? It's important to weigh how essential liquidity may be for your situation before pouring all of your cash into your home." So, how do you decide what's right for you? Ask yourself the following questions:.
Do you have higher-interest debts to pay off?
It's always best to focus on paying off higher-interest debt, since it saves you more in the long run, says Taylor. And it's common to pay more interest on a credit card than it is a mortgage, he explains. If you have significant credit card debt, consider focusing on paying down that debt first.
Does your mortgage include a prepayment penalty clause? "Not all lenders do this, but some contracts (usually if your mortgage is older) can come with prepayment penalties that will cost you a fee if you refinance or pay off your mortgage within a certain period of time (generally three to five years after closing on your initial mortgage)," says Taylor. "It may not be as common anymore, but it's certainly worth checking with your lender." If there's a prepayment penalty for paying off your mortgage early, you can make a smart decision by comparing the fee amount to what you'd save on interest.
Have you made investments ahead of retirement?
When weighing the option to pay or save more broadly, consider where your retirement plans and funds stand, says Taylor. Does your employer offer a good 401(k) contribution match amount? In that case, you might want to take full advantage of bolstering your retirement savings with that extra cash you were going to put toward paying off your mortgage. Or, maybe you're getting close to retirement and already have a healthy plan in place? In that case, investing may not be as much of a concern.
Have you considered a hybrid approach?
It doesn't have to be all or nothing, says Taylor. "Instead of paying off your mortgage in full, consider options like refinancing into a shorter loan term or making extra payments throughout your loan term to help you save on interest or pay off your mortgage sooner."
At the end of the day, everyone's financial situation and goals are different, says Taylor. There's also a personal preference factor: "What works for you or makes you feel the most comfortable may not align with someone else, and that's okay. Weigh your options and make the decision that's going to work best for you."