You may want to think twice about paying off your mortgage ahead of schedule.
A mortgage loan is a big debt, and your monthly loan payment could be one of the largest bills you have to pay. Because of that, you may be tempted to try to pay off your home loan early -- perhaps by making lump sum extra payments when you come into cash or by making extra payments each month as you work on loan repayment.
But before you go ahead and send more than the minimum to your mortgage lender, you should think seriously about whether early mortgage payoff is a smart financial move. The reality is, for most people, it's best not to pay off your loan ahead of schedule. Here are four big reasons why.
1. Mortgage interest rates are low
A mortgage is one of the least expensive kinds of debt there is. It's very common to be able to qualify for a loan at a rate of around 3% or less -- especially as mortgage rates have fallen during the COVID-19 pandemic.
Since rates are so low, devoting extra money toward paying your loan off early provides a very low return on investment (ROI). You could do much better financially by focusing on paying off higher interest debt first, such as credit card debt, personal loans, or even car loans.
Even after your debt is paid off, extra mortgage payments would still provide a low ROI. You could make safe investments, such as buying an S&P index fund, instead of paying extra toward your home loan. This could provide an average annual ROI of around 10%, which is well above the return from early loan payoff.
2. You'll be tying up your money
Once you've made extra mortgage payments, it's difficult and expensive to get back the money that you sent to your mortgage lender. You would either need to sell your home or refinance your mortgage loan -- which can come with expensive closing costs and can take time.
Instead of paying extra on your home loan and sinking so much money into an illiquid investment, you may be better off paying just the minimum and putting extra cash into an emergency fund or a more liquid investment you can sell easily if you need to.
3. You'll lose your mortgage interest deduction
If you itemize on your tax return, you can claim a deduction for mortgage interest. This means that your home loan becomes even cheaper. If you qualify for a $2,000 deduction and are in the 22% tax bracket, you could save up to $440 on your taxes. If you pay off your home loan early, you will give up this government subsidy sooner.
4. Your mortgage gets cheaper over time due to inflation
Inflation reduces the value of your money over time. For example, $1,000 today might only have $970 in buying power in a year's time if the inflation rate is 3%. But if you have a fixed-rate mortgage, your payment never changes -- which means it effectively gets cheaper over time since you're paying your loan with money that isn't worth as much.
Since paying your loan becomes less expensive each year -- especially during times of high inflation -- early payoff simply may not make financial sense. That's even more true when you consider the loss of the interest deduction, the loss of flexibility, and the lost opportunity costs to put your cash into investments with a better ROI.
For all these reasons, you may just want to think twice about sending any extra money to your mortgage lender.
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