Becoming debt free is as much a part of the American Dream as owning a home but there certainly can be conflicting circumstances that make the decision to pay off your mortgage early unclear.
The advantages of paying off debt early is increased cash flow, less interest paid and a higher credit score. The disadvantages are lower cash flow available as discretionary funds for meals, entertainment and other things. If the ultimate goal is financial security, is it worth the intermediate sacrifice?
Whether you pay off your mortgage early is a personal decision that may be right for one person and not for another. Consider the following before you get started:
Reasons you should
- Peace of mind knowing that you don’t have a mortgage
- You’ll save interest regardless of how low your mortgage rate is
- Lowering your housing costs before you retire
Reasons you shouldn’t
- You can invest at a higher rate than your mortgage
- You have other debt at a higher rate than your mortgage that needs to be paid off
- You might need the money in the future and want to remain liquid
- You might not qualify for a mortgage currently
- You should pay off other debt with higher interest rates
- Your employer has a matching retirement plan that would benefit you more
- You have more urgent financial needs like emergency fund, life, health and disability insurance
- You expect high inflation and the value of your mortgage debt will decrease
Use this Mortgage Accelerator to determine how quick you can pay off your mortgage.
Equity is an asset and an appreciating home is an investment. While some people have resolved themselves that a mortgage payment is a normal part of life, others have set goals to get their home paid for as soon as possible. There are several strategies that will work but they all require persistent vigilance.
Additional principal contributions to any length fixed-rate mortgage will save interest, build equity and shorten the term of the loan. Some homeowners may apply lump sums at various times during the year such as when bonuses are paid or a tax refund is received.A shorter term mortgage such as 20, 15 or even 10 years will not only pay off sooner, it will generally have a lower interest rate. A recent comparison at Freddie Mac’s Primary Mortgage Market Survey showed a 30 year fixed-rate mortgage at 4.04% compared to a 15 year fixed-rate at 3.20%. The fees for the shorter term were even .1% less. The shorter term with the lower rate would have a higher payment but some people consider it forced savings.
Other owners might increase their payment by $100, $200 or more each month. Setting the increased payment through electronic banking would insure that you consistently make the extra amount.
Bi-weekly payments make 26 half-payments in a year which equals 13 full-payments. Because of the frequency, it reduces the interest that is due. This might work well for borrowers who are paid every two weeks but could present cash flow problems for those who are paid on schedules that don’t coincide.
Making one extra payment a year will have almost the same effect as a bi-weekly payment. The 13th payment would be completely applied to principal.
Before embarking on one of these strategies, it would be wise to verify with your lender that it complies with their policies. Check out the Equity Accelerator to see how it could affect your loan.