Homeowners frequently ask if they should pay off their mortgage before they need to. The idea of being debt-free is very appealing, I’ll admit.
On the other hand, interest rates have reached historic lows in recent years, while the market has hit historic highs. That means you may be better off investing your money instead.
How can you decide?
As with many financial issues, there are several factors to consider and no one-size-fits-all answer. Here are some of the pluses and minuses.
Pros of paying off your mortgage:
- Reduced expenses: No mortgage means lower expenses and less need to draw down your savings in retirement.
- Forced savings: Directing funds into extra mortgage payments is a form of forced savings. Sure, it’s easy to say you’ll save and invest your excess cash, but are you really disciplined enough to do it? Many of us are not.
- Guaranteed return: Paying off your mortgage provides guaranteed savings in amount of the interest you shave off. The quicker you pay down the principal, the less chance the interest has to accumulate. Assuming you stay in your home, the amount of savings can add up significantly over time.
- Emotional satisfaction: For some people, the peace of mind they gain by becoming debt-free is the most important consideration of all.
Cons of paying off your mortgage:
- Illiquid assets: Once you put extra money into paying down your mortgage, you can’t get it back. If you become unemployed or encounter an emergency, you may be short on cash. Of course, you may be able to borrow against your home, but that, too, has an interest rate cost. Though rates are low now, they may be higher at the time when you need to borrow against your home.
- Opportunity cost: Money you invest has the potential to grow faster than the savings you gain by paying less mortgage interest.
- Tax deduction: Traditionally, the mortgage interest deduction has reduced the effective mortgage interest rate for many people. Under new tax law, however, some homeowners may find taking the standard deduction more beneficial than itemizing. Anyone considering a mortgage payoff should consider their individual tax consequences before making a change.
Even if the pros seem to outweigh the cons, you should answer some important questions about your savings and financial goals before deciding to pay down your mortgage. Are you maximizing your retirement plan savings and any employer match? Are you saving for your children’s education? Do you have a sufficient cash reserve for emergencies and large purchases? Have you paid down high-interest debt?
Ultimately, your decision may be based as much on your personal psychological makeup as it is on finances. For some, the security of having a home paid off outweighs the concern of missing potential market gains. Others may accept mortgage debt as an acceptable tradeoff for having more liquidity and investment opportunity.
To see even more pros and cons, check out this Nerdwallet article with arguments for and against paying off your mortgage early.