Every month, you send a significant portion of your income to your housing lender. And every month, you dream about what else you could do with that money—if only your mortgage was paid off already!
Wouldn’t it just be better to pay off your home loan early and be done with it?
Depending on your finances and goals, the answer might surprise you. Today, we’re going to cover six reasons why you would NOT want to pay off your mortgage early.
1. You Need Rainy Day Funds
Let’s take a gander at your monthly bills. It looks like you should have a couple hundred dollars remaining every month. Then why does that never seem to be the case? Well, last month the dog needed to go to the vet, and the month before that was your big family vacation, and the month before that the stove needed to be replaced… It may sound like a great idea to divert “extra funds” to your mortgage, but first make sure those funds aren’t needed elsewhere. Is your job secure, or are you planning on leaving soon? Do you have the recommended 12 months’ salary set aside for emergencies? If not, you could be better off putting extra money in a liquid account (such as a savings or money market account) each month, instead.
Which brings us to our next reason:
2. Home Equity is Not a Liquid Fund
Sure, paying down your home loan increases the equity you have in your home. But that figure does not directly translate into anything that is usable, should you need quick cash. Let’s say you lost your job or had to take on additional debt, like from medical bills. The only way to cash in that equity—to turn it from an illiquid asset to a liquid asset—would be to sell your house or borrow against it. The former scenario will likely net you more money if your loan is paid off. But depending on the housing market when you need the money, there’s no hard and fast way to say how long it will take to sell your home, or whether you’ll definitely come out ahead. Plus, you’re left without a house. The latter defeats the whole purpose of paying down the mortgage in the first place.
3. Your Mortgage is Not Your Highest Interest Debt
When you look at your mortgage statement, it’s easy to look at the ratio of your principal to interest on each payment and go a little cross eyed. But what is the interest rate on your home loan? Right now, the average 30-year fixed rate is hovering just over 3% (and is even lower for government-backed loans). Compare that to an average 5.8% interest rate for student loans or 17.89% for a new credit card and 14.52% for existing credit card accounts. If your goal is to avoid paying too much unnecessary interest, it’s always to your benefit to focus on debts with higher interest rates first. And don’t forget, once credit cards and other loans are paid down, you’ll have more money each month to invest in your mortgage, if that’s what you want.
4. Other Investments can Have a Higher Rate of Return
Would you give up $10 just to pay off $3? If you have extra cash, you could make more money investing it than you would save by paying off your mortgage more quickly. The historic rate of return on S&P stocks over the last 100 years is around 10%. True, investing can be risky and inconsistent. But if you’re investing in a well diversified, equity oriented, low-cost portfolio of index funds, you’re much more likely to net a higher yield in the long run. Sure, you could make those same investments once your mortgage is paid off. But even if you can cut a 30-year mortgage in half, you still lose 15 years of compound investment earnings. Now which decision sounds more risky?
5. You Won’t be Eligible for the Tax Deduction
Mortgage interest typically is tax deductible if it amounts to more than your standard deduction. In fact, for most people, home mortgage interest is the single largest income tax deduction available. Especially if you’re in a high tax bracket and have a relatively high mortgage, you may want to keep the mortgage rather than paying it off. Losing that tax benefit could put you in an even higher tax bracket, resulting in bigger tax liabilities on your annual returns. However, if your interest payments are relatively low, the tax savings could be less of a factor. Instead, you should consider whether investing extra cash in a tax-advantaged account such as a 401(k) or individual retirement account (IRA) would be a bigger benefit.
6. Retirement is Sneaking up on You Quickly
Your plans for the future should play a significant role in the financial decisions you make today. If retirement is more than a decade away, you still have time to invest now and build up a considerable nest egg. Maxing out your retirement savings and capturing your company’s matching contribution is one great way to do that. However, if your mortgage is relatively small and retirement is sneaking up sooner, paying off a mortgage could offer peace of mind and flexibility in your later years. Just keep in mind that Fidelity estimates retirees will need $220,000 for medical expenses alone during the course of retirement. If the funds you need are tied up in your home, tapping into them can be challenging, as we discussed above.
TL;DR: Paying off Your Mortgage Early Shouldn’t be Your Only Financial Goal
When it comes to your personal finances, there is one important thing to remember. Your choices rarely need to be all or nothing.
Hopefully, we’ve managed to show you the benefits of directing extra funds to liquid assets and long-term financial planning. But if you still want to pay down your mortgage principal more quickly, you can certainly do both. Even a few extra dollars a month, or a couple hundred each year, will compound over time and help you pay down your loan faster.
With a little planning and understanding of your own, unique finances it is possible to meet all your financial goals.
Need Help Organizing Your Home Ownership Goals?
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