Should you pay off your mortgage early
Many homeowners want to know how to pay off their mortgage faster, or if paying off their mortgage faster is the smartest way to spend their money. As for whether to pay off your mortgage early, don’t pay off your mortgage early if you lock in low interest rates. The reason is that it’s better to invest your money in the stock market, where a reasonably diversified portfolio of stocks can earn at least 7% on average over a decade or more. In other words, you don’t want to be paying off your mortgage at 4% APR when you’re investing in stocks and bonds or adding to your retirement through your brokerage account to earn a higher return. Deducting the interest on your mortgage and covering federal taxes, you’ll miss out on these benefits by paying off your mortgage early.
Instead of the standard 30 years to pay off their mortgage, my parents paid off their mortgage in less than 20 years. Why do many people pay off their mortgage early? Because it’s about their financial freedom and can relieve a lot of the stress that the loan puts on their lives. Many people share this view. When it comes down to it, they just don’t like debt. It’s as simple as that.
Many people claim a deduction for mortgage interest when they pay their taxes. With that in mind, let’s take a look at what the mortgage interest deduction really means. The easiest way to find out what the mortgage interest deduction is is to check your effective tax rate. For example, assuming a total tax rate of 22%, on average, for every $100 you pay in mortgage interest, the mortgage interest deduction is a tax deduction of $22.
The mortgage interest deduction is only valid for the standard deduction amount you deduct and is available to taxpayers who do not itemize their tax returns. As of 2018, the standard deduction is $24,000 for married couples and $12,000 for individuals. In addition, the new tax reform bill passed this year sets a $750,000 cap on the mortgage interest deduction, which means you can only deduct interest on home loan amounts below that cap.
What does this mean? By 2018, higher deductions mean that more and more people will be itemized for taxation. And, if you don’t itemize your taxes, then your mortgage deduction interest is worthless. And even if you do, it’s the only thing more worth saving than the standard deduction that anyone can take. In many cases, this will greatly reduce the value of the mortgage interest deduction, making it barely worth considering.
But what about lost investment returns? When you ask people if they want to pay off their mortgages early and why they want them, you’ll find many skeptics who disagree with the idea of taking on long-term debt and prefer to invest the extra dollars in the stock market. Because the stock market has historically performed well, the math favors those who choose to keep their low-interest mortgages and put in extra dollars. But with the uncertainty of the stock market, the interest savings from paying off your mortgage early is a “sure thing. Many people are happy to pay off their mortgage early and put their savings in the bank, even if it’s less than they would have made with the extra money. What are the different ways to pay off your mortgage early? Refinancing your mortgage – Most homeowners choose a 30-year mortgage, but a short-term refinance may mean a lower interest rate and a shorter time to pay off your mortgage. It can also save you money on the total interest on your loan, which is an added bonus.
Refinancing a mortgage – Refinancing a mortgage comes with transaction costs, so some homeowners choose to refinance their mortgage. A remortgage usually costs only a few hundred dollars in credit fees, and it allows you to reduce your monthly payments by making a single payment on the principal of your loan. This amount allows your lender to change the amortization schedule and reset the monthly payment amount without changing the interest rate or loan terms. Make as many payments as possible on one or both mortgages – even one additional payment per year may take several years to pay off your mortgage. A common way to reduce the length of your payments is to make bi-weekly payments instead of monthly payments, which equates to 13 payments per month instead of 12. Lump sum payments will reduce your balance – A lump sum payment of principal will reduce your total loan balance. Homeowners who receive an influx of cash through work bonuses, tax refunds, estate taxes, settlements or other sources may want to keep these funds for this purpose.
Contact your lender before creating a mortgage repayment plan. Not every lender allows bi-weekly repayments, and some charge prepayment default fees for early principal repayment. Refinancing may mean a guaranteed shorter loan term and a lower interest rate, but it also means higher monthly payments and additional closing costs, for which you must pay a small fee. On the other hand, a lump sum principal payment or recast may not be feasible for homeowners who don’t have access to more cash.
As someone who loves math but despises debt, I see both sides of the issue. That’s why my family takes a balanced approach. My strategy has always been to max out my retirement account first and then spend a few hundred dollars more each month on my mortgage. I could pay off the house faster, but I don’t want to save less for retirement. In the end, only you can decide what to do with your mortgage debt. When you hate debt, it’s understandable that you want to put it behind you once and for all. Just make sure that any decision you make is a wise one.
