12 Good Reasons Why You Should (and Should Not) Pay Off Your Mortgage Early

Do I think it’s wise for you to pay off your mortgage early?

You may as well ask me if I think it is a good idea if you paint your living room sage green.

I used to think paying off your mortgage was an absolute no-brainer.

Then I did a complete 180, changing direction like one of those day-glo orange heliport windsocks. Oh yes, I did.

After resurveying the macroeconomic condition of the United States and trying to interpret the future direction of its fiscal policy, I was ready to declare that maybe, just maybe, prepaying the mortgage isn’t a good idea after all.

Suddenly it just didn’t seem like it made much sense to pay down a 30-year $120,000 mortgage at 4.5% interest if I truly believed that high-inflation was inevitable down the road as a result of Fed’s relentlessly lax monetary policy and the current administration’s plans to greatly expand the size of the Federal government and its entitlement programs.

The question of whether or not I think you should pay off your mortgage is not as cut-and-dried as, say, whether or not I think you should pay off your credit card balances in full each month. Of course you should pay off your credit cards in full each month; but when it comes to paying off the mortgage early, there are solid arguments that can be made either way.

Here are 12 good reasons why you should — and should not — pay off your mortgage early. Which ones resonate most with you?

Good Reasons Why You SHOULDN’T Pay Off Your Mortgage Early

1. You haven’t capitalized on your employer’s company match to your workplace retirement plan.

If, for example, your employer matches you dollar-for-dollar on the first 3% of your contributions to your 401(k) plan, then you’re throwing away free money. If he matches even half that amount, then you’re still passing on a sure-fire 50% return on your money. Opportunities like that don’t come up too often. Take advantage of them when you can.

2. You have other debt that accrues at a higher interest rate than your home loan.

It makes no sense to pay off a mortgage if you’re carrying credit card debt at a higher interest rate. When you pay off a credit card with a 15% interest rate, for example, then every dollar of debt you pay off earns you an instant 15% return. Not too shabby.

3. You have yet to establish an emergency fund equal to at least three months of living expenses.

It doesn’t make much sense to be making extra payments on your mortgage if you can’t withstand a sudden loss of income due to unemployment, or suffer a major financial expense that forces you to choose between paying the mortgage or, for example, having a major car repair made.

4. You want to maintain more liquidity/flexibility.

Many people like to have a ready source of funds that can be easily converted to cash in order to quickly react to business opportunities, for example.

5. You owe significantly more on your house than it is currently worth.

If your mortgage is upside down, the fact is you are more susceptible to foreclosure if you lose your job or suffer some other hardship that prevents you from making your payments.

6. You have a family but haven’t yet established life, health and disability insurance.

If you are the lone bread-winner in the household, how will the mortgage be paid if you die, suffer a catastrophic health problem, or become severely disabled?

7. You have a low fixed-rate loan and anticipate a bout of severe inflation.

Inflation is a debtor’s best friend. If you have a fixed rate mortgage with a very high balance, you might even want to root for high inflation. That’s because inflation erodes the value of money, and when inflation is on the rise the value of your mortgage debt becomes less over time. For those who have fixed rate mortgages, the higher the inflation, the faster the value of that debt is reduced. Many people ask why they should pay off a fixed rate loan with more expensive dollars today if they strongly suspect those dollars will be worth significantly less within, say, the next five years or so.

8. You are confident you can get better returns elsewhere.

Let’s say you have a mortgage with an interest rate of 5%. But in reality your effective, after-tax interest rate on your loan is less than that. If you’re paying, say, 25% of your household income to federal and state tax collectors, then your effective interest rate is 25% (your tax rate) less than the original 5% — or only 3.75%. After determining your effective interest rate, you may decide the bar is low enough that you’d rather try earning a bigger return elsewhere.

Good Reasons Why You SHOULD Pay Off Your Mortgage Early

1. You’re the type that believes peace of mind is priceless.

How do you sleep at night? I know more than a few people with paid-off mortgages that swear they sleep like a baby every single time their head hits the pillow.

2. You want to remove the cost of your mortgage from your future living expenses before you retire.

What better way to temper the impacts of living on a fixed income than by making sure your mortgage is paid off before you retire?

3. You’re more concerned with getting a steady guaranteed return than risking a bigger payday through the stock market or other investment opportunities.

As far as Suze Orman is concerned, it makes more sense to pay off your home before making investments anywhere else:

You cannot live in a tax return. You cannot live in a stock certificate. You live in your home.

4. You simply hate the idea of paying interest.

People who have the best grip on their personal finances naturally abhor paying interest. Personally, I hate paying interest. To anybody. For anything. But that’s just me.

So Is Paying Off Your Mortgage Early A Good Idea?

Well, that depends. In the end, the “correct” answer really comes down to which reasons are most important to you.

Don’t let anybody tell you otherwise.

***

For additional perspectives on this topic from the Money Mavens, check out these articles:

Money Help for Christians: Pay Off Mortgage Sooner, Invest, Or Save? The Math Analysis

Joe Taxpayer: Pay the Mortgage Early or Save?

Wealth Pilgrim: Free Calculator: Pay Off Your Mortgage or Invest?

Green Panda Tree House: Pay Off Your Mortgage or Invest Your Money?

Enemy of Debt: Should You Grow Your Nest Egg or Pay Off Your Mortgage?

Comments

  1. 2

    says

    Great analysis Len.

    The pros and cons are spot on. This isn’t a no-brainer for anyone, because everyone’s situation is different. And, their needs and goals are different.

    The only thing that is a no-brainer is Good Reason #2. Retiring with a mortgage or while renting, really puts some stress on a fixed income.

  2. 3

    says

    You forgot the tax deduction. Not a reason to have a home loan mind you, but if you are in a high taxed and make a high income, it’s one of the last deductions you have.

    Here is a site to get your mortgage rate with the tax deduction:

    http://www.bankrate.com/calculators/mortgages/loan-tax-deduction-calculator.aspx

    IMHO the cut off for pre-paying your mortgage is around 8% (before tax savings) as it is pretty hard to beat that investing in the stock market.

    At current mortgage rates, it almost makes no sense in most cases. As you get older, near retirement and the deductions decrease it makes sense to pay off.
    .-= Investor Junkie´s last blog ..Our 2010 Hyundai Genesis Purchase =-.

    • 5

      says

      @Bret: Up until very recently I was one who was absolutely fanatical about paying down the mortgage and I thought everybody else should too. The longer I’m around, the more I am seeing how both points of view can make sense – it all depends on what we value.
      @InvestorJunkie: Yep. Good catch. I probably forgot it cuz I’m not lucky enough to make so much that I would notice that. LOL
      @Joe: I thought the list approach was a natural way to tackle this topic. Glad you thought so too.

      • 6

        says

        @Len,

        As you know, I was also fanatical about paying it off early and I’m still doing it. Even though it may not make sense to some mathmatically, I just wanted to be mortgage-free by the time I turned 51. I felt that I could make some great lifestyle changes, such as early retirement or going out on my own, if I had zero debt and payments. Now that I am closing in on that goal, I’m certainly glad I have done it. I will trade financial freedom for consumer items, any day of the week.

        Bret

  3. 7

    says

    i can agree with a few points on both sides of the fence. if you have not taken full advantage of 401k opportunity and have other debt then you should definitely not try to pay off your house. but if you have other debt it would be hard to pay off your house in the first place.

    if you are getting ready to retire then it makes total sense to pay off your house as you want as few bills as possible to enjoy retirement.

    either way in the long run it makes sense to pay off your house if you are in that position. how nice would it be to get an offer for $200k to $400k and know that all that money was coming straight for your bank account? pretty nice…

  4. 8

    says

    I paid off my mortgage, and I do sleep like a baby at night but…

    That said, today with lending rates sooo low, I don’t think I would pay off a mortgage. Especially if the house you are thinking about purchasing cost more that $250,000. Higher price homes do have larger tax advantages (via itemizing it). But with lower price homes, the standard deduction may high enough to nullify any tax advantage from itemizing the mortgage interest.

    I guess it all comes down to the borrower’s interest rate, how much the borrower earns (their tax rate), and how debt averse you are.
    .-= Money Reasons´s last blog ..BP Oil Spill, Selling On Bad News =-.

  5. 9

    says

    Love the Article. Thoughtful and well presented.

    I would push towards 6 or even a 9 month contingency fund before I started paying too much extra principal though. Perhaps work toward both with equal payments.

    Things in our economy are a bit more volatile these days and a bigger buffer can mitigate some of the risks.

    I personally lean slightly toward paying the mortgage off early with extra principal payments each month (Make sure your lender is applying them immediately. Sometimes it is better to send in the extra principal as a separate transaction…with a note:For Principal Only). There is a huge sense of satisfaction in watching the principal drop.

    -WR
    .-= WR´s last blog ..Contingency Theories =-.

  6. 10

    says

    You are right. It all boils down to what is most important to you.

    Peace of mind seems to be one of these elusive things. If you want peace of mind and you pay off your mortgage to get it, you might also want a good cash cushion for emergencies. Therefore you got to be in a very good financial position to (a) have enough cash on hand for emergencies and (b) be able to pay off the mortgage. When you are in a financial state like that, peace of mind comes naturally….unless you stole the money and you are still scared that you might get caught. ;-)

  7. 11

    says

    Len, HOME RUN! This article is perfect!!! You hit on all of the key point. If you have a 4.5% mortgage and can get 7% return on your cash, YOU ARE MAKING MONEY WITH THE LEVERAGE OF THE MORTGAGE. I loved every point. Best, Barb

  8. 12

    Susan Tiner says

    It can be a diversification strategy too, paying off the mortgage, because real estate is a different market and doesn’t necessarily move in tandem with capital markets.

  9. 13

    says

    I ALWAYS love this debate as a homeowner, for some reason.

    I’ve decided to pay off my rental property within 10 years of the first day of ownership, and pay off my primary residence in a normal 30 yr amortizing fashion b/c there is a high likelihood I will move within 10 years. No point locking cash in. Besides, the rate is sub 5%, and I have older CDs at the same level.

    Cheers,

    Sam
    .-= Financial Samurai´s last blog ..Pretend You Have Arrived So You Can Become =-.

  10. 14

    says

    Great post. I was initially skeptical when I read the title because, like you, I’m pretty much of the mind that you definitely need to aggresively pay it off (provided that you are 1) out of debt, 2) have emergency, and 3) have invested for retirement). However, UR right in that there are some other issues to consider. Thanks for writing a balanced post.
    .-= Roshawn @ Watson Inc´s last blog ..Uncommon Money News (Vol. 92) =-.

    • 15

      says

      @MoneyReasons: I agree. In my case I have the added advantage that, after years of diligent saving, I already have enough money saved up to pay off my mortgage balance at any time if I so desired. At any time I think my latest position is wrong, I can use those savings to pay off the mortgage off.
      @Ctreit and WR: Without that emergency fund, it really doesn’t make sense to make additional mortgage payments. Although, WR, I think nine months is a *really* beefy fund. Great if you can build one, but not sure everything else should be put on hold until you get to that total. Maybe wait until you get to three months, then split the difference by continuing to add to the emergency fund (albeit at a slower rate) AND pay down the mortgage? Just my two cents…
      @Barb: Yee haw! I feel like Babe Ruth right now! :-)
      @Susan: Great point!
      @Sam: Hey, that is clever. I think that is a smart way to split the difference.
      @Roshawn: At times, I still catch myself doubting my latest course of action. It is a very tough decision to be sure.

  11. 16

    says

    I like the way you’ve set this up with the different points on both sides of the question.

    It’s crystalized a thought in my mind, that paying off the mortgage is a worthy goal on the list of financial things to do. But as you’ve listed building an emergency fund, maximizing 401k contribs, paying off non-mortgage debt, etc, paying off the mortgage might be down around #7 or 8 on the list. Worth doing yes, but a high priority, no.
    .-= Kevin@OutOfYourRut´s last blog ..Income Sources You’ll Be Richer For Not Having Tried — Part 2 =-.

  12. 17

    says

    This was a well-written and comprehensive post flipping both sides of the coin. I will be sure to share this with our online community as this is a question we get quite frequently. Great post!
    Suzanne
    Social Media Specialist
    CareOne Debt Relief Services

  13. 20

    says

    I have to say that I am guilty of #6 in the “DON’T” category. I am the sole breadwinner and we don’t have life insurance yet. I don’t know why I’ve been dragging my feet but I have. Your other reasons are very sound as well. We have a ton of student loan debt higher than our mortgage. We need to work on that first and then it will lead to paying off other things.

  14. 22

    Financial Bondage says

    a paid for home 100% of the time can not be foreclosed on. Paying off your home frees up lots of money in your budget for giving and saving and investing.

    • 23

      tim says

      A paid for home for which the property taxes are not paid yearly can and will easily be foreclosed on. While it will not be a bank taking the home, it will be no comfort to know that the local government owns your house.

      • 24

        connie says

        LOL…. our property tax and SID fees ( SID is basically city taxes…suburban improvement distict) TOTAL ( TOTAL!) a whopping $247.08 a year… so I dont think there is any fear of being foreclosed on if my house if paid off. … sure beats the devilish property taxes we paid up in Illinois. OMG!!!!

        • 25

          Kelvin says

          Total $247.08 taxes a year! Which state and city do you live in? I’m retired and need to consider moving there?
          Please advise.

  15. 26

    says

    Love this topic. I don’t plan to pay off my mortgage until I retire. I like having more reasons to work. Without a mortgage, life would be too easy and earning money would be pointless! lol.

    It’s just accounting really.

  16. 27

    says

    Actually, for those folks out there with financially stable situations, large, low cost mortgage debt is a good thing. If you have a mortgage with a 5% interest rate, and you can invest that borrowed money at 7%, you are making money on your mortgage. That said, this idea is not for those with any other higher interest rate debt or without an emergency fund, retirement fund, college savings for the kids etc.

  17. 29

    says

    @Sam and @Barb: I used to be in the “Pay It Off Early” camp, but with the US devaluing the dollar with all this deficit spending and money printing, I am now content to simply pay the mortgage down gradually and let higher inflation eat away at the value of what I owe. No sense paying down my mortgage early with dollars that are more valuable today when I can pay them off with what will surely be far-less valuable bucks tomorrow. I wish it didn’t have to be that way, but…

  18. 30

    Alice H.Street says

    Way behind on making correct financial choices for my future. Currently working full time, with the opportunity to be fully vested in 2012 (a 10 yr requirement 2002 to 2012), None other past jobs that I have had in the last40 years offer any pension with the exception of current job. Early in my adult life my pension was in the education field, left to start a family, never to return on a full time basis. In the years following,my work then consisted of sales and marketing, raising 4 children,early death of spouse, then for a period of time the sole support of self and children and eventually, secretarial (current)Do not have any options other than Social Security and minimal retirement,less than $1,000. per month. Savings has been depleted by differen family emergencies and poor management and foresight.

  19. 31

    says

    Hey Len

    Nice one. Just goes to show there is more than one way to skin the cat – that is why it is called personal finance. It is good you brought into light the factors that sway the decision one way or the other.

  20. 32

    Ben says

    To Barb’s point about 5% interest rate and 7% return on investment. Please do tell where one can get a 7% return on their money.

    CD’s pay around 1% for a year, the stock market is heavily manipulated by High Frequency Trading as well as the Fed’s monetary policy, which makes the stock market about as risky as table games at a casino.

    Aside from buying low grade corporate debt, i would love know where one can geta 7% return on their money?

    Also Len, on the inflation issue. I will agree that paying off a mortgage with inflated dollars in the future is in fact good as the dollars are worth less. However, if you have enough money to pay off your mortgage now, isn’t that money in your account going to be worth less to as a result of inflation? So what difference does it make if you pay it off now with saved money? If the money you pay it off is devalued, so is the money you’re saving, right?

    • 33

      Len Penzo says

      Ben, regarding the inflation issue… that’s only true if you save the money. Ideally, if you really believed high inflation was inevitable down the road, one wouldn’t simply place the extra money they were putting towards the principle in a savings account; the better strategy would be to invest that money or spend it ASAP on real estate, tangible products and/or commodities.

    • 34

      anh says

      Hi, Ben. I think you have to take a little risk and be a little creative if you want to make 7% interest on your money. It is not easy but very possible. For example, i took money out of my house and bought another property that is making 9.5% net income on the price and operating costs of that home. My tenant is actually helping me pay my mortage. By the way my fixed rate is 4.375% for 30-year. I dont feel rushed to pay it off because our mortgage is so low, but i do make extra payment each month ($500). I think as time goes by my net income will increase to help me pay my mortgage even more.
      My reason for doing this is to get my mortgage payment is low as possible now so i have even more savings and enjoy life while i am young.
      I dont want to have wait until i am old to pay off my loan. I want to enjoy life now

  21. 35

    Brian says

    Like the article in lots of ways.
    Just can not understand why it
    would not make sense to give your
    self a big raise of say your mortgage
    payment , Mine being about $920 a month
    for my primary home. I am in the process
    of doing this now as I now have created
    a emergency fund for a 6 month period and
    have maxed my 401k contribrutions. Lots of
    peace of mind to know that I will be able to
    know my house is mine and not have to pay
    for all the extra’s with mandatory insurance
    and all. Able to take lots of hard earn money
    and place it in greater amounts to a interest
    bearing account and create tax shelters of
    some sort with my money, rather than always
    giving it to the mortgage company and insurance
    aggency.. Not a master money person, just like
    the mortage payment raise better than the low
    interest rates and time to create the numbers my
    mortage payment can give me quicker for my
    golder years.
    Brian

  22. 36

    Marklan says

    I’ve never understood the reason why they say you need to pay off a credit card that has a higher interest rate first before you pay off a mortgage with a lower rate. Example with my mortgage: The rate on my credit card is 14.9%. My mortgage rate is 6.125%. My mortgage payment is $709/mo but $393 of that is going to pay interest that month. So really I’m paying 55.4% interest that month compared to 14.9%.

    • 37

      Len Penzo says

      Well, that’s true. But you’re kind of mixing apples and oranges, Marklan. That conventional wisdom applies only to credit cards.

    • 38

      Glen says

      Marklan, your logic makes no sense. Just because 55.4% of a particular payment went to interest does not mean that is your interest rate. How much of a particular payment goes to interest when you pay your credit card? Say you charge $100 on your credit card at 14.9% after one month you would accrue $14.9/12 = $1.24 in interest charges. So, suppose you made a credit card payment of $1.24, then 100% of your payment would be interest and you would never pay your balance off. To really compare the two, figure paying your credit card off in 30 years like your mortgage and see how much money you’d waste, the amount would be staggering!

      And Len, the ‘conventional wisdom’ does not only apply to credit cards. Compound interest is compound interest. Would you rather charge your house on a credit card at 14.9% interest or get a mortgage at 6.125%, the choice is obvious, as is the choice of which to pay off first.

      • 39

        Len Penzo says

        Touche, Glen. :-) I realize compound interest is compound interest. When I wrote that my mind was inexplicably vapor locked into the mindset that ridiculously low mortgage interest rates would be with us forever — and therefore didn’t apply. Thanks for knocking me back to reality.

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