For most Americans, getting a mortgage is the only way to enter the housing market. And while it's an incredible tool that, generally, is fairly affordable to maintain over the long term, it does come with a very expensive caveat -- mortgage interest. That's why those who have saved up a nice lump sum of money may wonder: Should I pay off my mortgage or not?
Let's take a deep dive into why you may want to pay off your mortgage early, the pros and cons of early mortgage repayment, and ways you can achieve this if desired.
Getting rid of pesky interest
A home loan can be both a blessing and a curse. On the one hand, the mortgage allows you to purchase real estate when you likely don't have all the money needed to purchase it with cash. On the other hand, getting a mortgage also means you'll have to pay interest on the amount borrowed (principal balance).
Depending on the type of loan you get -- which can be a fixed-rate mortgage, interest-only, variable, or balloon -- the interest paid can be more than you originally borrowed to purchase the home.
Most people don't think about how much they pay in interest over time, instead choosing to focus on how much the monthly mortgage payment is: Is the monthly payment affordable, and does it fall in line with their budget? But paying off a mortgage early means you can eliminate tens of thousands of dollars in interest while also eliminating your mortgage payment altogether.
Pros and cons of early payoff
The obvious pros for paying off your mortgage early are saving money in interest over time and freeing up additional cash today. If you have a rental property and around 50% of your cash flow goes to debt service, paying off the mortgage could result in 50% higher cash flow than before.
Eliminating debt -- no matter if it's a student loan, credit card debt, a car loan, or a home loan -- can also provide tremendous peace of mind in knowing you don't have to worry about repaying anyone if you were to suffer a loss of income or another financial burden.
But there are some negatives to this as well. Some mortgage lenders have a prepayment penalty, which says if a mortgage is paid off before a certain date, the borrower will be charged a fee. And that could negate the effort of paying off the mortgage early to begin with. Property owners also have the benefit of utilizing the mortgage interest deduction, which is a great tax deduction that allows you to deduct the interest paid on a loan each year.
Strategies for paying off a mortgage early
Setting aside money in a savings account each month until you've accumulated enough to pay off the mortgage balance is definitely one way to approach an early payoff. But it's not the only way. A number of homeowners and investors will make an extra mortgage payment each month.
You can also set up biweekly mortgage payments that exceed your scheduled monthly principal and interest payment. A lot of investors use this strategy, taking any additional cash flow earned from a rental property and using it to pay down the mortgage at a faster rate. It's important to discuss with your lender that you want any additional payment you make credited toward the principal balance, which helps lower how much is owed each month (i.e., saving you interest).
You also have the ability to refinance your mortgage to get more favorable mortgage terms such as a shorter loan term (e.g., from 30 years to 15) or lower interest rate.
Who are early mortgage payments right for?
Paying off your mortgage early can be extremely beneficial, creating additional cash flow from a rental property and freeing up personal cash for other investments or other personal needs. But that doesn't mean it's right for everyone. It really comes down to your financial goals, amount of expendable cash you can put toward paying down your mortgage, interest rate, and loan term.
The higher your mortgage interest rate is, the more beneficial it is to pay down your mortgage debt early because you will pay less interest over time. If you have a low, fixed interest rate, you may be able to put that same money to use in another investment that will yield you more than you pay in interest, ultimately earning you money while paying the debt.
You should also make sure that you are contributing your extra cash to other important accounts, including your retirement account and savings accounts. While it may be great to pay off debt, you want to make sure you still have money for the future or potential emergencies.