What Do I Need To Consider When Deciding To Pay Off Some Or All Of My Mortgage
- What is the interest rate on your mortgage, and how does it compare to the interest you can get on a savings account? There is also the potential you pay tax on those savings.
- Are there any penalties for repaying the mortgage early? If you are on a fixed rate or discounted mortgage, there might be significant costs for paying it off early
- Are you expecting any windfalls, such as selling a business, or inheritance? If you are expecting a large amount in the near future, there is probably less downside to paying off the mortgage
- Do you have alternative investments that you want to make e.g. buying another property, or building up a business?
- How much money do you need for a rainy day fund? We suggest a minimum of three months outgoings, but six months is safer
- What costs are you expecting? If you have years of school fees ahead of you, you might want to keep a large ring-fenced sum aside so you know you can to cover them, rather than paying off the mortgage. An off set mortgage might fit the bill in this instance.
- Are you expecting a decrease in income? In which case, you might want to keep extra savings to tide you over.
Paying Off Your Mortgage Early: When And How To Do It
There are a number of strategies you can follow to pay off your mortgage faster. By refinancing or making extra quarterly payments, you can shave months, or even years, off your pay-off date.
Edited byChris JenningsUpdated October 12, 2021
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When you take out a mortgage, you might feel uneasy at the thought of carrying debt and paying high interest costs over time. Paying off your mortgage early, however, could help you save money and rid yourself of some financial stress.
Before you make extra mortgage payments or zero out the debt entirely, you should consider whether its the best move for you. It may make sense in some circumstances, but not all.
Heres what you need to know about paying off your mortgage early:
No Paying Your Mortgage Early Is Silly
We already know that the common argument against paying off your mortgage early is to earn larger returns in the stock market. The historic return on stocks invested in the S& P 500 has been on the order of 10% per year going all the way back to 1928. It doesnt make sense to pay off a mortgage that has a 4% interest rate, and give up likely returns on equity investments of 10%.
It could be argued that once your mortgage is paid off, youll have more money to invest in stocks. But even if youre able to reduce a 30 year mortgage to 15 years, you will still have lost 15 years of compound investment earnings. Thatll be close to impossible to make up.
But this is risky, and theres nothing wrong with forgoing larger returns for a guaranteed return and peace of mind. But there are other, perhaps more compelling, arguments against paying down a mortgage early.
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Refinance Your Mortgage Into A Shorter
Got a 30-year mortgage? Refinancing it as a 15-year loan will blast you through that mortgage a whole lot faster, and will probably get you a better interest rate as well — shorter loan terms are typically paired with lower interest rates. And thanks to the shorter time frame, you’ll pay a lot less money in interest — so the payments on a 15-year loan are not double the payments of a 30-year loan they’re significantly less. Pull up a mortgage payoff calculator and play around with the numbers to see how much you’d have to pay to do a 15-year refinance. And if the monthly mortgage payment for such a loan would be more money than you can afford, consider a 20-year loan instead.
How Much Do You Value Peace Of Mind
Sometimes its less about the bottom line and more about peace of mind. If you own your home free and clear, that can provide benefits that cant be measured in strictly financial terms. For many, eliminating a monthly mortgage payment ahead of retirement can provide mental relief when considering living on a fixed income.
Personally, Im paying down my mortgage, says Thomas of Mission Wealth. It feels good to have it paid off before retirement. It might not always make financial sense, but it offers peace of mind and it might allow for better budgeting.
Another potential advantage is the ability to borrow against the equity in your home. Having a considerable amount of equity can allow you to establish a home equity line of credit , providing a source of emergency income, as well as allowing you to make home improvements or make progress toward other financial goals.
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How To Decide If You Should Pay Off Your Mortgage Or Invest
Your decision on this matter will come down to your individual circumstances and your financial goals. This includes both the numbers and your own priorities. Here are some things to take into account.
- Rate of return Compare mortgage rates to the historical rate of return on the investment youre considering. Will you get a higher rate of return when investing? Which will give you better long-term results?
- Your feelings about debt If you have the goal of being debt-free, this can be a significant factor in your decision.
- Your risk tolerance Will having more money tied up in the stock market add to your stress? Can you ride out dips in the market?
- When you want to retire If youre heavily focused on retirement, the best option for you may be to max out your 401 or other retirement account. Consider talking to a financial adviser to figure out the best strategy for you.
- How long you want to stay in your home If youre planning to move soon, tying up extra money in your home loan might not pay off.
What To Do If You Haven’t Paid Off Your Mortgage By Retirement
If you’re nearing retirement age and still owe a significant amount on your home, consider continuing to work until age 70. That gives you more time to pay down your debts while still earning income. “Stop saving at work and plow the extra money that will pop into your paycheck to reducing your mortgage debt ASAP,” Orman wrote for Money.
Working even a few more years helps increase your retirement savings substantially, she says: “Your retirement accounts will last you longer and hopefully have grown over that period of time, which hopefully will generate more income for you.”
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You Are Still Saving For Big Purchases
Its not enough to pay off debt and save before tackling the mortgage. Its also important to make sure you have future cash needs addressed. Generally, you should plan to cover significant purchases for at least the next five years, and 10 years would be preferable. Typical big purchases might include the following:
Theres no point in paying off the mortgage only to go into more debt for a large purchase.
Consider Your Pension Before Paying Off Your Mortgage
Remember that money saved into a pension is tax free, so before repaying your mortgage, you may want to consider putting more into your pension.
Money can be taken from your pension at age 55 or 57 depending on your terms and conditions, so if your pension fund is earning 5% interest and therefore making more interest than your mortgage is costing then it may be worth saving more into a pension and using that money if you still owe money on your mortgage when you gain access to your pension.
You can get advice on your pension options at the Government website MoneyHelper
Financial Freedom To Pursue Other Ventures
A pleasant advantage of paying off your mortgage, assuming you have no other debt, is that it may give you the financial freedom to pursue other ventures.
Whether you have always dreamed of living somewhere tropical, traveling around the world, or owning your own business, having extra money in your bank account every month will allow you to pursue other economic opportunities.
When To Pay Off Your Mortgage Early
Paying down your mortgage balance early can remove some financial stress and allow you to focus on other financial goals. You might consider doing this if:
- Youre financially secure in other areas. If youve maxed out your retirement contributions, your emergency fund is well stocked, and youve paid down other debts, then paying down your mortgage could be the next logical step.
- You have a plan for the extra money in your budget. Its a good idea to make a plan for what youll do with the extra money when you no longer have a monthly mortgage payment. This can help ensure you dont spend the extra money on frivolous purchases. For instance, you might decide to invest the extra cash.
- You want to gain peace of mind. Some homeowners pay down their mortgages simply because they no longer want a large monthly payment hanging over their head. This can be especially helpful if youre about to retire or you live on a fixed income.
- You dont mind if your assets are less liquid. When you pay off your mortgage, you own the entire house and your net worth climbs. But if you ever need to tap your equity, youll need to either sell the home or take out a home equity loan. Both steps take time and come with extra costs.
Refinance to a Smaller Loan: 10-Year Fixed Refinance Rates
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What Happens When You Pay Off Your Mortgage
See Mortgage Rate Quotes for Your Home
Paying off your mortgage is a momentous event, and one that should be celebrated. However, before popping open the bubbly, its important to know what happens when you pay off your mortgage to avoid any unpleasant surprises. This includes obtaining the proper payoff documents, closing out your escrow account, and making sure you redirect your tax and homeowners insurance bills so you dont miss a payment.
The Pros Of Paying Off Your Mortgage Early
- Save money on interest. Each month that you make a mortgage payment, some money is going toward interest so the fewer payments you have, the less you will pay in interest. Paying off your mortgage early could save you tens of thousands of dollars.
- No more monthly payments. By eliminating monthly mortgage payments, you free up that cashflow to put toward other things. For example, you could invest the extra money or pay for your child’s college tuition.
- You own the home outright. If you hit a financial rough patch, there’s the possibility that you won’t be able to afford monthly mortgage payments. Your house could be foreclosed upon if you default on payments. When you completely own the home, there’s no chance of losing the house.
- Peace of mind. You may simply like the idea of not having a mortgage hanging over your head. The freedom that no mortgage payments gives you is a powerful motivator.
Benefits Of Paying Off Your Mortgage
Kirsten Rohrs Schmitt is an accomplished professional editor, writer, proofreader, and fact-checker. She has expertise in finance, investing, real estate, and world history. Throughout her career, she has written and edited content for numerous consumer magazines and websites, crafted resumes and social media content for business owners, and created collateral for academia and nonprofits. Kirsten is also the founder and director of Your Best Edit find her on LinkedIn and Facebook.
Lea Uradu, J.D. is graduate of the University of Maryland School of Law, a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, Tax Writer, and Founder of L.A.W. Tax Resolution Services. Lea has worked with hundreds of federal individual and expat tax clients.
Mortgages account for the most common type of personal debt in the United States. Why? Because when you take out a home loan, depending on the type of mortgage, you generally finance 80% of the home price. But the total cost of a mortgage isn’t just the actual price tag on a home, it includes the interest you pay on the loan itself.
For example, if you take out a 30-year fixed mortgage loan, you can plan on sending a payment to your lender for the next three decadesunless you decide to pay off your mortgage early.
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Are You Putting Money Into A Pension Scheme
On a £150,000 mortgage at 5% with 25 years remaining, paying off a £5,000 lump sum will reduce the interest by £11,500 and the repayment term by 18 months.
Pensions are a tax-efficient way to save because the government tops up your contributions with tax relief.
And, if you have a workplace pension your employer should pay into the scheme too.
Find out more about workplace pensions in our guide Automatic enrolment an introduction
If you dont have a pension and have money to spare, its important to think about paying into one.
The earlier you start, the sooner your retirement pot will start to grow. With employer contributions and tax relief from the government, you might get more for your money in a pension than youd save in mortgage interest.
Find out more in our guides:
Disadvantage: Missed Savings Interest Or Pension Benefits
Paying off a mortgage may not be the best option for you if savings interest rates are more than the interest you pay on your mortgage.
Similarly, if you dont have a comfortable pension pot saved for your retirement, its worth considering making a large contribution to your pension plan to take advantage of the tax benefits this may provide.
Weighing up these options is complex and varies depending on the financial markets. Make sure you receive professional financial advice before you decide whether to invest your money or pay off your mortgage.
Options for paying off your mortgage early
There are two main ways to pay your mortgage off early: pay a lump sum in full or increase your monthly payments.
Overpaying your monthly payments may suit you if your household has an increase in your regular monthly income, such as getting a promotion at work. Its also a good way to take advantage of low interest rates: paying off as much as you can while interest rates are low means therell be less of your mortgage remaining to pay off when interest rates are high.
You have a few options to consider:
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Interest Saved From Paying Off Mortgage
For the mortgage with the 3.5% interest rate, the total interest cost for the 30-year loan would be $123,312, and the borrower would save $20,270 by paying it off 10 years early.
Although saving more than $20,000 in interest is significant, the interest amount saved represents only 17% of the total interest cost for the 30-year loan. In other words, $103,042 in interest has already been paid in the loan’s first 20 years , representing 83% of the total interest over the life of the loan.
As mentioned earlier, the structure of the amortization schedule for a mortgage leads to most of the interest being paid in the early years.
How Should I Pay Off My Mortgage Early
Take a look at your finances to work out if you have any surplus cash that you can use to pay down your mortgage, each month.
If you can overpay, it’s well worth doing. Say, for instance, you have £135,000 outstanding on your 25-year, 5.25% fixed rate mortgage. An overpayment of £100 a month would take your repayments from £809.98 to £909.98 a month.
However, it would also cut 5 years off your mortgage term and save you more than £25,000 in interest, making overpaying an option that’s definitely worth considering in your quest towards paying off your mortgage early.
You need to make it clear when you overpay whether youd like to reduce your mortgage term or your monthly payouts. If you dont, lenders might take that decision out of your hands leaving you with the less desirable outcome of the two.
Check your mortgage terms and conditions to make sure overpayments are allowed
Find out if overpayments now might entitle you to a mortgage holiday later, should you need it
If youre wondering how to pay off your mortgage early, overpaying will definitely have a big impact on reducing your debt.
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