Thirty years can seem like a really long time to be giving a large chunk of your paycheck to someone else each month. Being able to put that money into your pocket instead of your mortgage is such a nice thought, so obviously using any extra cash to pay down the principal balance on your mortgage is the smart thing to do, right? Not necessarily. There are many factors to consider when it comes to paying off your mortgage early. For example, you could invest that cash elsewhere for a much higher return on investment. We know, we know. You’ve always been told that putting more money toward your mortgage principal each month is the best thing to do. While it is a smart move in many cases, there are some instances where that money would do more for you in a different type of investment. Confused? Here are three reasons you should and three reasons you should not use your extra cash to pay down your mortgage.
Reasons to Pay Down Your Mortgage
Peace of Mind. Owning your home free and clear gives you a little more financial freedom and peace of mind. You’ll never have to worry about foreclosure because you lost your job, for example, and can’t make mortgage payments for a few months. And if you do ever decide to sell your home, there won’t be any mortgage payoff to make; you’ll have a large chunk of money to make a down payment on your next house, or simply buy it outright with cash. Paying off your mortgage could also help motivate you to become completely debt-free, which is always a good feeling!
Interest Savings. This one’s relatively simple to understand. Since you pay interest on the principal balance of a mortgage each month, the earlier you pay off your mortgage, the less you’ll pay overall. For example, say you have a $300,000, 30-year fixed rate mortgage with an interest rate or 4.5%, and your monthly payment is $1,520. If you committed to paying a little more toward the principal balance each month, say $1,820 total, you’d save almost $80,000 in interest and pay off the loan eight and a half years earlier. That’s a lot of savings!
Cost of Living Reduction. It’s probably safe to say that your mortgage is the most significant bill you pay each month. Eliminating that bill earlier than you have to means you’ll be able to live on less income, save more for retirement, put money toward opening your own business or even travel more often. Having more cash each month gives you the flexibility to live your life the way you want it and not be a slave to your mortgage.
Reasons Not to Pay Down Your Mortgage
Opportunity Cost. While it’s true that you’ll have more financial freedom in the long run, paying down your mortgage early ties up all your extra cash. Every extra dollar you spend on your mortgage is a dollar you can’t invest elsewhere. Therefore, if you have a low interest rate, paying more toward your mortgage might not make the most financial sense. You might be better off putting those extra dollars in a retirement fund or other investment that will get you a higher return on your investment. While you might be saving $80,000 on your loan over time, you might very well have the opportunity to make $100,000 if you invest in a different financial goal. Consult your financial planner to see what other investments are available to you for a better ROI.
Tax Breaks. Don’t forget that mortgage interest is tax-deductible. If you itemize when doing your taxes, this might be something you need to think about. You’ll be losing out on a deduction if you pay off your mortgage early. Additionally, if you choose to pay down your mortgage instead of putting money into a tax-advantaged savings account for retirement, you’d be losing out on that tax break as well. So if you contribute an extra $5,500 toward your mortgage instead of putting the same amount in a 401(K) or an IRA, you would be missing out on $1,210 in tax savings if you’re in the 22% tax bracket.
Lack of Diversification. When it comes to investing, putting all your eggs in one basket isn’t usually the best move. If you sink all of your extra cash into your mortgage, you’ve essentially just tied yourself down to real estate investing. If your home doesn’t increase—or even worse, decreases—in value over the years, what do you really have to show for your money? Your net worth won’t have increased unless you have money invested in other assets. You won’t have any liquid assets, which means getting money back from your investment will be a lot harder.
As you can see, just as with any financial planning advice, this is a decision that must be made on a case-by-case basis. Weigh the pros and cons and decide what’s most important to you. If reducing your cost of living and being able to retire early is more important to you than having liquid assets, then paying down your mortgage early might be the best choice for you. If you’d rather diversify and take a chance on higher-yield investments while continuing to pay your low-interest mortgage, investing your extra cash elsewhere is the better decision.