You No Longer Have To Weigh The Cost Of Your Mortgage Against Other Investments
Investing is a balancing act that requires careful planning to avoid working against yourself. Your mortgage is probably the most significant loan you have taken out, and the cost of the interest you are paying adds up over the years and decades.
You can and should make certain investments even if you have a mortgagelike your 401K or IRA investment accounts others are less clear. For an investment to make sense while you owe money to the mortgage company, it will need to deliver a rate of return that exceeds your mortgage interest.
Otherwise, you would be better paying the mortgage off early. But if you have paid the mortgage off, you do not need to weigh your investments against your home loanbecause you are no longer paying interest on the loan.
When money is cheap with rock bottom interest rates, the pendulum usually swings in favor of keeping a mortgage. On the flip side, if you have a high mortgage interest rate paying off your mortgage could make more sense.
Of course, if you decide keeping your mortgage makes more sense than paying it off early, you would be foolish not to refinance into a lower interest rate.
You can go for a no points, no closing costs loan, and keep the same amount of years to amortize the mortgage. You will have a lower interest rate while also paying off the loan in the originally scheduled time frame.
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What Will Give You The Most Growth
The most important factor when evaluating your options is that of growth. A dollar spent paying down a mortgage is one that could be invested elsewhere. You want your money to work for you, so the question to ask is, What option will give you the biggest payoff? In this case, you will find the answer by pitting your mortgage interest rate against your expected investment return. You can calculate some rough numbers to assess which decision would make more financial sense.
Lets look at an example to give you some context. Say your mortgage interest rate is 5%. If you estimate that, based on your risk tolerance and time horizon, you can pursue an investment return of 4%, it would make more sense to pay down your mortgage. Otherwise, you are potentially throwing away 1%. However, if you are not as conservative with your investments and believe you could earn 8% on your investment, it might be more beneficial to invest.
This may sound simple on paper, but there are plenty of factors that could affect the outcome. And as we all know, even the best return estimates are far from guaranteed. It is important to run a thorough analysis and consider taxes on investments, mortgage interest deductions, risk, and private mortgage insurance, among the other elements of your financial life.
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Can You Afford To Prepay Your Mortgage
Before you pay down your mortgage ahead of schedule, you need to make sure you aren’t neglecting other important needs. For instance, if you have high-interest credit cards, higher-interest short-term debt on a car, or a private student loan, you should look at paying off that debt before you consider paying off what may be a lower-interest-rate mortgage.
Also, if you are still working and have not taken full advantage of an IRA or 401, those savings options come with significant tax benefits, and maybe even an employer match. The tax benefits and match may make investing in these accounts more appealing than paying off low-interest-rate debt, like a mortgageparticularly if you are concerned you won’t have enough funds for retirement.
Paying Off Early Means Increased Sequence Of Return Risk
Paying off your mortgage early means foregoing adding more to your investment portfolio today. The effect is that most of your investments are compressed into a smaller time frame — post-mortgage payoff — which increases your exposure to sequence of return risk.
Sequence of return risk is the potential for a few years in the stock market to have an outsized impact on your investment portfolio. If the stock market has a few bad years in a row when you have most of your money invested, the impact is significant. Likewise, if the market goes on a tear for a few years and you have practically nothing invested, you’ll have missed out on a significant portion of returns the market provides.
Since stocks are more volatile than other assets, the real benefit of the asset class — greater expected returns — is often seen over long periods of time. But if your investment horizon is shorter, you could face several years of poor returns at the most inopportune time. That risk is mitigated with more time invested in the stock market, which means spreading your investments out over as much time as possible.
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Why Banks Hate When You Pay Off Your Mortgage Early
Banks are legal entities that operate with a unilateral financial objective to generate profits the more, the better!
It is just that simple.
The interest income generated from a portfolio of mortgage loans tends to be one of the banks most significant revenue sources. However, the exact proportion of revenue depends on the lenders diversification.
But any way you slice it, lenders never appreciate it when a mortgage contract is paid in full early.
When a mortgagor/borrower chooses to pay their mortgage in full before the mortgage instruments last scheduled payment, the banks fiscal strategists must now revise its anticipated income expectations downward, even if only temporarily. This unexpected cash flow reduction slashes revenue that eventually disrupts funding for budgetary items like the offering of additional customer services, or the ability to fund new future-planned projects, etc.
And, to make matters even more challenging, bank executives are now tasked with the responsibility of locating another safe, well-performing, collateralized financial investment that pays returns that are similar to the mortgage that was just paid off.
However, this task is not always simple to complete because the market and interest fluctuations occur daily, monthly, and yearly, etc.
What You’ll Learn
Tips For Buying A Home
- A financial advisor can guide you through major financial decisions, like the purchase of a home. SmartAssets free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals, get started now.
- Securing a mortgage can be a stressful and confusing process. For starters, you need to figure out what term is best for you, whether you want a fixed or variable interest rate and where to get the best mortgage rates.
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You Could Get A Small Knock On Your Credit Score
One of the factors that go into your credit score is your the different loans you have at any time. When you pay your mortgage off, it drops out of your credit mix. That could lead to a small drop in your credit score.
The credit mix you possess contributes ten percent of your overall credit score. Considering this, it should be understood that other creditors see you paying your mortgage each month as a good thing.
When they determine your viability as a borrower, its excellent they see you making your payments on time each month.
You’ll Have Less Liquidity
Liquidity refers to how quickly you can access your money when you need to. Savings accounts are very liquid — you can take a withdrawal from one when you want and get your money right away. Stocks are also fairly liquid — you can sell a stock with relative ease for cash — though they’re not quite as liquid as savings accounts.
Homes, on the other hand, are very illiquid. You can’t easily and quickly sell a home for cash. It could take months to find a buyer and wait for that deal to close. So when you pay off your mortgage early, you tie up more money in your home, leaving yourself with less liquidity, or less access to money you might need in an emergency or for another reason.
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Investing In The Stock Market
If youve got some extra money every month, there are other things you could do with it. You could invest it with the expectation of getting a return on that money. That return could be pretty good, depending on what you invest in, but it can also be risky.
The returns can be significant. Consider the S& P 500, an index that tracks the performance of about 500 of the largest publicly traded U.S. companies. It has averaged a return of more than 10% since its creation in 1926. Other investment options, such as bonds, carry lower returns but also less risk, Spencer says. With a balanced portfolio of diversified low-cost index funds, you could expect an average return of around 6% or more per year.
Choosing to invest instead of paying more towards your mortgage means taking on risk as markets move up and down. Experts say you should think of it as a long-term deal and focus on the expectation of returns over 30 years. I balance the risk and return to make sure I have a positive arbitrage but dont put too much of the portfolio at risk, Hyde says.
You Cannot Put The Money Towards Other Investments
It will probably take a focused financial push on your part to pay the mortgage off early. All that money you pour into the mortgage could be put into other investments that might yield higher returns.
The average return on the S& P stock market index over the past 90 years was around 10%, whereas the rate on a standard mortgage for 30 years is about 4.5%.
Few would advise you to dump all your money into stocks instead of your mortgagestocks carry much more riskbut it is worth remembering that you could earn more from stocks.
Ultimately Paying Off Your Mortgage Early Depends On You
In this article weve evaluated the requirements to obtain different types of mortgages, as well as the implications for each type of mortgage. And ultimately answering the question of paying off your mortgage early will depend on your personal preferences.
For many people, the thought of owing a bank or the HDB hundreds of thousands of dollars on their mortgage is stressful. When viewed through this lens, it certainly makes sense to pay off your mortgage early in order to reduce debt on your personal balance sheet so you can breathe easier.
However, if you can tolerate the debt of a mortgage on your personal balance sheet and remain disciplined enough to invest your capital into investments that produce a higher rate of return than the cost of your mortgage, you will have the opportunity to increase the utility of your capital much more dramatically than paying off your mortgage earlier.
The best financial strategies typically balance these competing desires. If you have questions about finding the right property for you, we recommend you reach out to the team for expert opinions on picking the right property and deciding on the optimal mortgage repayment schedule.
Disclaimer: Information provided on this website is general in nature and does not constitute financial advice.
What’s The Right Move For You
Paying off a mortgage early is a personal choice, so there’s no right or wrong answer as to whether it makes sense to do so given today’s interest rates. If you’re thinking of making extra mortgage payments to knock out your loan ahead of schedule, ask yourself:
- Can I afford to put more into my mortgage right now?
- What am I giving up to pay down my home loan, and it is worth it?
- Am I trying to repay my home loan in time for a certain milestone, like retirement?
From there, you can let your answers guide your decision so you ultimately make the right call.
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Mistake #: Extending Your Loan Term When Refinancing
Refinancing can save you money in multiple ways, as it allows you to convert to either a shorter or longer loan term, depending on whats best for you. So if youre 10 years into a 30-year mortgage term, you could potentially refinance to a 10-year term and shave off 10 years. On the flip side, you could go for another 30-year term to lower your monthly payments.
However, loans with shorter terms tend to have lower interest rates, allowing you to both save on interest and reach full ownership much sooner. In some cases, though, refinancing could cost you more in the long run, especially if youre planning to extend your loan term. Before you refinance, its a good idea to crunch some numbers and figure out whether having a longer mortgage term really makes sense.
Dont forget closing costs either. If your lender agrees to let you roll those costs into your loan, you could end up paying more money. After all, youll now be on the hook for interest on a larger loan amount.
How To Pay Off A Mortgage Early
There are a few ways to pay off your mortgage early. For one, you can add additional funds say an extra $50 to your monthly mortgage payment. Youll need to clarify that these funds should go toward the principal otherwise, the lender might apply it toward the following months payment. Most lenders let you assign the extra payments to the principal online.
Adding just $50 to each monthly payment could save you thousands of dollars in interest.
Even a small amount tacked on to your required payment can save you thousands of dollars in interest over the life of the loan. On a $250,000 mortgage at 3.25% for 30 years, an extra monthly payment of $50 can cut at least two years off the mortgage and save you $11,405.09 in interest.
You can also make additional one-time or irregular payments during the year. For instance, you may want to apply some of your tax refund toward your loan principal. Even if these extra payments are inconsistent, they can help you shorten the loan and save money in interest.
Refinancing is a common early repayment tactic. This essentially means you take out a new loan to pay off the current loan, then start your mortgage over based on the remaining loan balance and the equity youve established.
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Shop For The Best Rate
Quite often, then, buyers will stick with banks or financial institutions they already know and have accounts with. But when shopping for the best mortgage rate, its actually better to cast your net wide and far. Consider outside-of-the box lenders, including credit unions and mono-lenders , as quite often these institutions can offer much better rates and terms than big banks.
Rent Out Extra Space In Your House
If you want to make extra payments but dont know where to find the money in your budget, consider putting your house to work.
Some examples of what you could do include:
- Renting out an extra room
- Turning an accessory dwelling unit into an Airbnb
- Renting out space in your garage for storage
- Renting out a parking spot
- Renting your pool or backyard out to someone for an event
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Consider Your Full Financial Picture Not Just Your Debt
- Mortgage rates are near record lows right now.
- Investing instead of paying down debt will increase your buying power over the long run.
- Holding a mortgage can actually mitigate the risks of inflation and stock market volatility.
Paying off a mortgage early can free up cash flow and save a lot of money on interest payments. But investors shouldn’t view their mortgage in a vacuum. Putting extra money toward a mortgage can be seen as part of an overall investment plan.
While there are reasons why paying off your mortgage early makes sense in certain cases, many investors are better off paying the minimum every month. Here are three reasons why.
Create A Budget And Stick To It
The most effective way to gain the funds to pay off your mortgage early is to reduce your number of nonessential expenses. Eliminating vacations, unnecessary purchases and dinners out can go a long way in helping you to reduce your personal spending. When deciding to pay off your mortgage early, make sure you begin by developing a budget for all of your spending. A personal budget can go a long way in helping you monitor your finances and become more intentional about what you do spend.
Paying off your mortgage faster can be tempting, as it enables you to finally own your home outright, get ahead of your debts and start investing your money. However, you dont want to use all your available funds on your mortgage only to find that youve left yourself without enough money to make it through any emergencies that may arise. To avoid such pitfalls, its crucial that you educate yourself on your options before deciding to pay off your mortgage early.
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