Should You Pay Off Your Mortgage Early?

Many homeowners face a common dilemma – should they pay off their mortgage or invest? There are obvious pros and cons for each situation, and since each situation is unique, there is no one-size-fits-all answer to the question.

Should I Pay Off My Mortgage Early?

We recently received this reader question from someone who has the ability to pay off his mortgage, but isn’t sure if it is the right decision. Here is the question:

We re-financed in 2003 to a 15-year mortgage and currently have a balance of $66,000. We can easily afford to pay it off right now while still having considerable investments. Due to the differing opinions on the subject, we’re not sure whether we should pay off the mortgage or not.

Thoughts?

I’m not sure there is a right or wrong answer to your question – at least based on the information we have at hand. Even though we can’t give you a specific answer to your question, we can point out a few factors to consider to help you make the best decision for your situation.





Before Paying Off Your Mortgage…

Do you have any other debt? If so, then you should probably try and eliminate other debt first, especially if it is higher interest or on a depreciating asset (like a car). Why? Mortgage debt is typically lower interest than other loans and your mortgage interest is tax deductible if you itemize your taxes (you don’t want to keep a mortgage just for a tax deduction, but it makes more sense to keep a mortgage over other debts if the interest is lower or your can’t deduct interest from other loans).

Do you have an emergency fund? You should consider how much money you will have left in your emergency fund if you pay off your mortgage in full. Will you have enough cash to handle any unexpected expenses? Will you be able to sleep comfortably at night knowing you have enough ready cash to handle any emergency. Do you have other savings outside of your emergency fund? For example, will you need to make a large ticket purchase in the near future (car, vacation, home repairs, etc)?

What about retirement funds? Are you investing in your 401k or IRA, or both? If you are already maxing these out, and have an emergency fund, then paying off your mortgage might be a good idea to eliminate your mortgage debt once and for all. On a similar note, paying off your mortgage may also be a good idea if it increase your cash flow enough that you will be able to contribute more to your retirement funds, or otherwise use the money productively.

Where is the money coming from? Is the money you would use in a standard savings account, in a CD ladder, or other liquid account? Or would you have to cash in investments to get the cash you need? You definitely want to avoid early withdrawal penalties, so you wouldn’t want to do this if you would need to tap into retirement funds. You may also wish to avoid cashing out other investments if you would incur a large tax bill. Non-retirement investments are still subject to capital gains taxes, which can be as low as 15% if you held the investment for over a year, or as high as your normal tax bracket if you have held the investment for less than a year. So the money you save on mortgage interest may not be worth cashing in the investments if you will be on the hook for 15% (or more) in taxes.

Do you have a plan? Paying off your mortgage is a huge achievement – but do you have a plan for what you will do next? Your mortgage is likely your biggest monthly commitment, and paying it off should dramatically increase your cash flow. Before paying off your mortgage, have a discussion with your spouse about how you will handle the additional cash flow each month. Will you use it to pay off other debts, increase retirement fund contributions, invest outside of retirement funds, or something else?

You don’t have to use 100% of the additional cash flow for investing or other “responsible” activities. But you do need to be aware of how your new found cash flow can change your spending habits. You want to avoid lifestyle inflation if you can help it.




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Date published: December 20, 2010.

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Ryan Guina is the founder and editor of this site. He is a writer, small business owner, and entrepreneur. He served over 6 years on active duty in the USAF and is currently serving in the IL Air National Guard. He also writes about money management, small business, and career topics at Cash Money Life. You can also see his profile on Google.

Comments

  1. Ryan,

    Great post. It leaves plenty to think about. I will point out that although I know that you were speaking in general terms, it is likely that this couple is no longer gathering any benefits of a mortgage interest deduction. With a balance of 66K and only seven years remaining on their mortgage, I’m sure that they are paying way less than their standard deduction.

  2. Ryan, I think this is a common struggle. We talk about it regularly and have yet to make a convincing argument for paying off the mortgage on either of our properties. Particularly since they get rented out regularly, the interest deduction balances out our income nicely. If we were to hit Romeo’s situation, and expect to stay in a house for a length of time, then perhaps paying off the mortgage would make more sense for us.

    In addition to the other considerations you listed, I would suggest they think about how they feel about the mortgage. Does having a mortgage make them feel weighted down, or do they not really care? Would there be a great psychological benefit to paying it off, or not so much?

    It is a great question, and unfortunately the answer is rarely clear.

    • The psychological aspect is one that certainly merits a lot of consideration. The idea of being completely debt free is very appealing to many people, myself included.

      There are certainly many factors to consider, and a decision this large can’t be made in a bubble.

  3. I think part of it depends on your interest rate as well. If you are locked in at 5% and you can make more than that by investing the money that should be taken into consideration

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