It can be tempting to pay off your mortgage early, especially if you have the funds readily available. You can retire debt-free, save on interest and even divert those savings to higher-earning investments.
But there are drawbacks to consider, too, and paying off your mortgage early isnt the right move for everyone. If youre looking to free up cash, a mortgage refinance may be a better option.
If you elect to go the payoff, route, however, there are a series of considerations you should first make. Heres what to think about.
Paying off your mortgage early can seem like a great idea. You’ll save money on interest build equity faster and enjoy the peace of mind of owning your home free and clear. However, an early mortgage payoff also has some potential downsides to consider. Examining the key pros and cons can help you decide if it aligns with your financial goals.
Pros of Paying Off Your Mortgage Early
Here are some of the main advantages of paying off your home loan ahead of schedule
You’ll Save Money on Interest
This is one of the biggest pros of paying off your mortgage early. By shortening your loan term, you’ll reduce the total amount you pay in interest over the life of the loan. This can lead to considerable interest savings, especially if you have a high mortgage rate or a lot of years left on your loan. The sooner you pay it off, the more interest you’ll avoid.
You’ll Build Home Equity Faster
Making extra mortgage payments increases the share of your home that you outright own. This gives you equity that you can tap into later via a home equity loan or line of credit. Building equity more quickly can be beneficial if you want to borrow against your home in the future.
You’ll Own Your Home Outright
For many people, the peace of mind of owning their home free and clear is a major motivator for early repayment. Once your mortgage is paid off, you’ll enjoy the security and satisfaction of outright homeownership.
You’ll Free Up Cash Flow
With no more monthly mortgage payment, you’ll free up money that can be redirected to other goals. This extra cash flow provides more flexibility in your budget. You’ll have the freedom to spend or invest the funds as you see fit.
Cons of Paying Off Your Mortgage Early
While the pros are compelling, there are also some potential drawbacks of an early payoff to review:
You May Miss Out on Investment Returns
Paying off a low-rate mortgage leaves less money available to invest for higher returns elsewhere. This “opportunity cost” is a key downside, as you may miss out on returns that exceed your mortgage rate – especially in strong markets.
You’ll Have Less Financial Flexibility
Extra mortgage payments reduce liquidity in your budget. Having less readily available cash on hand makes it harder to access funds for emergencies or other needs. This reduced flexibility is a risk.
You’ll Lose a Valuable Tax Deduction
Mortgage interest is often deductible on your tax return. By paying off your loan early, you’ll lose this deduction and potentially pay more in taxes. For some homeowners, this deduction is too valuable to give up.
You May Take a Small Hit to Your Credit Score
When any installment loan is paid off, your credit mix shrinks and your score may drop a few points as a result. For some borrowers, this minor impact is a drawback worth noting.
Key Factors to Consider
When weighing the pros and cons, here are some key factors to consider:
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Your mortgage interest rate – The higher your rate, the more interest savings from paying off early.
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Your emergency fund – It’s unwise to pay off your mortgage if you lack savings to cover 3-6 months of expenses.
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Your tax situation – Look at how the lost mortgage interest deduction may impact your taxes.
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Prepayment penalties – Make sure your loan doesn’t charge extra fees for early repayment.
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Your time horizon – Early payoff appeals more to those nearing retirement vs. young borrowers.
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Investment opportunities – Consider if you could earn higher returns by investing extra cash vs. paying off your mortgage.
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Your risk tolerance – Paying off your mortgage provides a “guaranteed” return for risk-averse borrowers.
Alternatives to Early Payoff
If an early mortgage payoff doesn’t make sense for you right now, here are some options for putting extra funds to work:
- Contribute more to retirement accounts like 401(k) plans and IRAs
- Invest through a taxable brokerage account
- Put money into CDs or high-yield savings for other goals
- Pay down higher interest debts like credit cards first
The right approach depends on your full financial situation. A financial advisor can help analyze the tradeoffs and create a personalized plan.
The Bottom Line
There are solid pros and cons on both sides of the early mortgage payoff decision. Take time to review the key considerations and weigh them according to your needs and priorities. For many borrowers, making extra payments can be smart. For others, it may make more sense to invest the funds or pay down higher rate debts first. Carefully analyzing your full financial picture can help determine the best path.
Con: You lose a tax deduction
Homeownership comes with quite a few tax advantages. One of the biggest is the mortgage interest deduction, which allows you to write off the interest you pay toward your mortgage loan each year — as long as your balance is $750,000 or less.
When you pay off your mortgage, you forgo this valuable deduction, and it could increase your taxable income quite a bit.
A quick note: The mortgage interest deduction is only available if you itemize your returns. For many homeowners, taking the standard deduction (instead of itemizing) is more beneficial. The current standard deduction is $12,950 to $25,900, depending on your tax filing status.
Con: You may have to pay a prepayment penalty
Potential prepayment penalties are another drawback to consider. Some lenders charge fees if you pay off your loan too early, as it eats into their ability to make a profit.
These fees vary, but generally, its a small percentage of the outstanding loan balance. These penalties are typically only charged if youre very early on in your loan term — usually within the first three to five years, according to the Consumer Financial Protection Bureau. Not all mortgage lenders charge prepayment penalties, though, so make sure to check with yours if youre considering paying off your loan in full.
Pros and Cons of Paying Off Your Mortgage Early
FAQ
What is the downside of paying off your house?
Peace of mind, saving on interest and building equity are three benefits of paying off your mortgage. Downsides include opportunity cost, reduced liquidity and removing a major tax deduction. A financial professional can advise you on the most appropriate options for your financial situation.
Do you pay more taxes if you pay off your house?
After paying off your mortgage, you should notify your accountant. You’ll no longer have mortgage interest to deduct on your tax return, which could potentially increase your tax liability.
Is it better to pay off a mortgage or leave a small balance?
They typical answer is that paying down the mortgage is better financially for you, but these are odd times with climbing rates and people with extremely low mortgage rates. You can easily make a small spread with no risk and give you more down payment on your next home compared to just paying down on the home.
What does Suze Orman say about paying off your house?
While the possibility of job loss can trigger financial panic, Orman advises against rushing to drain your savings to pay off your mortgage early. Even if you have enough money saved to wipe out your mortgage, don’t pull the emergency cord until absolutely necessary.