A home mortgage is one of the most substantial debts that individuals carry. It can be tempting to pay off your mortgage early if you have the funds available, which can lead many individuals to debate if they should. Unfortunately, there is no simple answer to whether it is a smart financial move as it depends on your long-term financial goals and personal circumstances. The decision requires thoughtful evaluation of your liquid assets, existing debts, and the potential impact on your financial stability. Working with a Financial Planning Professional to create a financial plan can help you understand any potential impact on your situation.
Personal factors to consider:
- Your financial health: Do you have sufficient funds to pay off the mortgage without compromising your emergency fund or short-term financial goals? Additionally, it is important to evaluate all of your debts as high-interest debts should typically be prioritized over a mortgage with a lower interest rate.
- Do you have a low mortgage rate, or could you refinance to a lower mortgage rate?: If your mortgage interest rate is low (i.e., under 3%), continuing regular payments might be more financially beneficial than paying off your mortgage early. This is because the interest you save may be less than what you could potentially earn from other investments. If you do not have a low mortgage rate, can you refinance to a lower rate? This strategy can also reduce your monthly payments adding to your cash flow. In today’s market, many investments offer returns that exceed mortgage interest costs, suggesting that continuing with your mortgage (especially a low-interest-rate mortgage) may be a smarter use of your money. However, it’s crucial to assess the after-tax returns of these investments to ensure a fair comparison. For instance, while a 5% yield from a money-market fund appears favorable against a sub-3% mortgage rate, high federal and state taxes could reduce your effective after-tax yield to around 3%.
- Personal and lifestyle factors: How much value do you place on being debt-free? The psychological relief of eliminating your mortgage can be significant, especially if it reduces anxiety over debt. In addition, you want to evaluate how paying off your mortgage early would affect your funds and thus lifestyle in retirement. Consider whether paying off your mortgage necessitates diverting investments that are integral to achieving your long-term goals. This decision weighs the benefits of being debt-free against the potential to enhance your retirement savings through continued investment.
Making the Decision
Benefits of Paying Off Your Mortgage Early
- Increased cash flow: Paying off or reducing your mortgage may increase your monthly cash flow and save on interest.
- Reduced financial stress: The absence of a monthly mortgage payment may lead to greater financial freedom and reduce stress.
Possible Drawbacks of Paying Off Your Mortgage Early
- Tax implications: When sourcing funds to pay down your mortgage, it’s important to be aware of any tax consequences that could negatively impact other components of your financial situation (i.e. crossing AGI or MAGI thresholds, loss of credits or deductions, etc.).
- Reduced liquidity: Paying off your mortgage early could reduce your financial flexibility, leaving less available for emergencies, etc.
- Loss of potential funds: If your investments are performing better than your mortgage interest rate, you may lose out on potential returns.
Paying off your mortgage early is appealing and in some instances may be beneficial, but requires a balanced assessment of your finances and current market conditions. Consulting with a Financial Planning Professional can provide tailored advice and help you ensure that your choice supports your overall financial well-being.
Written by: Alexis Houlihan, CFP®, CSLP® | Financial Advisor
Written: March 21, 2024