Should you pay off your mortgage early?

So you have bought a house. Congratulations! Now you’re wondering if you should pay off your mortgage early. Let’s explore some of the reasons why people choose to pay off their mortgage early and why people choose not to pay off their mortgage early.

Pros of paying off mortgage early

Lower monthly expense

Mortgage and rent. They are the biggest expenses that most people spend their paychecks on. Therefore, people usually aim to reduce the biggest expense, in this case, their mortgage.

Once you have paid off your mortgage, you no longer have to make monthly payment for principal and interest on your house. Your monthly expense will be reduced significantly.

Save on interest

Mortgage interest is usually calculated based on the remaining principal. You pay more in interest and less in principal in the beginning. Therefore, by paying down the principle early, you save more on interest.

A $300,000 home purchase with 20% down at 3.5% fixed interest rate for 30 years will not have an interest amount of $10,500, but will be $147,974.61 on $240,000 loan. It is more than 50% of the loan.

Why is the interest so high?

It is because of the way it is calculated. More of your mortgage payment goes toward more of your interest than principal in the early years. Since the interest is calculated based on the remaining balance, reducing the principal balance or paying it off early will greatly reduce the amount of interest you will have to pay.

Peace of mind

Sometimes, there is just nothing compared to not having to worry about the biggest expense or debt. Getting rid of the biggest payment can give you a peace of mind.

Cons of paying off your mortgage early

Cash locked in your house

The biggest downsize of paying off your mortgage early is that the entire cash amount that you paid extra to pay off early is now locked in your house. You can’t access that amount until you sell your house.

You can always take out HELOC (Home Equity Line of Credit) or reverse mortgage. But they are loans with interest.

Less money to invest in other investments

While making payments for the house, instead of using the extra cash to pay off the house early, you can also invest in a rental property, mutual fund that gives higher interest rate than the rate you’re paying, or other investments.

By locking your cash in the house, you may lose the opportunity to invest that amount in investments that could generate higher return.

No mortgage interest tax deduction

When you have mortgage, you can get tax deduction for part of the mortgage interest that you paid that year. The amount of tax deduction is not much compared to the amount of interest you paid and will save by paying off early, if you intend to use the house as primary residence.

However, if the property in question is a rental property, since the rent pays for the interest, it may benefit you more to have tax deduction for mprtgage interest to keep more of what you earn. Check with your accountant or tax advisor regarding your specific situation.

Pros of NOT paying off mortgage early

Keep more cash

By not paying extra, you can keep more cash to either help with other expenses, set aside for emergency fund, pay off higher interest debts or invest in other investments that will give higher returns.

Mortgage interest tax deduction

When you are still paying for the mortgage, you can get tax deduction for mortgage interest. This does not mean you can deduct the entire mortgage interest amount that you paid. For more information, please contact your tax advisor.

Earn higher return

If you already have a low interest rate for your mortgage, instead of locking your cash in the house, you can use the extra cash to invest in other investments that has higher return rate.

Cons of NOT paying off mortgage early

Pay more in interest

Because the mortgage interest is based on the remaining balance, the longer you wait to pay down the principal, the more interest you pay.

However, if it is a rental property, it may not matter much since the tenant’s rent covers the mortgage interest.

Conclusion

So should you pay off your mortgage early?

The answer depends on what your goal is and what your current financial situation is. Determining what your goal is and weighing the the pros and cons of paying off or not paying off your mortgage early can help you find a solution that fits your financial situation.