You’ve bought your first house. Now, everywhere you turn, you hear the same advice: pay off your mortgage early.
Ultimately, the idea behind this advice is that you should get rid off all debt as quickly as you can.
But is this really the right thing to do in all circumstances? Are the benefits of paying off your debt early that great?
In fact, what if you used that money in a more beneficial way?
How much could you save when you pay off your mortgage early?
Interest is usually the main reason for paying off your mortgage early.
For example, say you borrow $210,000 for your home at 3.92% APR. After 30 years, you will have paid $147,448 in interest, according to Google mortgage calculator.
Bankrate has a calculator that can help you figure out how quickly you can pay off your debt, and how much you will save.
Under Bankrate’s calculator, if you add an extra $500 to your payment each month, you could shorten your repayment time by 14 years and three months. And, save $75,802 in the process.
That’s a pretty big chunk of change over time.
Tax deduction: your mortgage isn’t as expensive as you think
Paying off your mortgage early is seen as a great way to save money on interest. And, it can be a good way to reduce what you pay overall.
However, your mortgage might not be as expensive as you think, thanks to the mortgage interest tax deduction.
When you itemize your deductions using Schedule A, you can deduct the mortgage interest you pay from your income. This reduces your tax liability.
Using the information for our example mortgage in the calculator from CalcXML, it’s possible to see that the cumulative tax savings from the mortgage over 30 years are $36,382 if you are in the 25 percent tax bracket.
Although that’s not enough to offset the interest you pay, it does reduce the overall financial impact.
What else could that money be doing?
Like the rent vs. buy a home argument, the real question is this: what else could you be doing with that money?
For instance, an early mortgage payoff guarantees you a return equal to your interest rate. But is it really that great to get a 3.92 percent annualized return?
What if, instead of putting that extra $500 towards paying your mortgage off early, you invested it.
Calculate My Wealth offers some numbers for different scenarios involving your investment.
One scenario shows that after investing your extra mortgage payment for 15 years, you could end up with as much as $207,377. Depending on where you put that money, of course.
And, if you keep that investment train rolling for 30 years, you could end up with more than $1 million. That’s your retirement right there.
Plus, at the end of that 30 years, you’ll still have your house paid off.
Suddenly, it feels like you could be doing something much better with that money than paying off your mortgage early, right?
Of course, all investment decisions come with risk. You could lose money in the stock market. Even though, historically, stocks haven’t lost in any 25-year period.
In fact, indexing can help you pace the market, rather than worry about individual stocks.
Your home could also appreciate significantly over time, boosting the value of your accumulated equity.
On the other hand, as we’ve seen, your home could lose value if the real estate market crashes. For most markets, though, home values increase at a modest rate over time.
The good news is that you don’t have to choose. You can work on paying off your mortgage on the standard schedule and invest what would have gone to paying off your mortgage early.
If you do both, and you could be sitting really pretty once retirement rolls around.
Cash flow considerations
Let’s not forget about cash flow, folks.
In our mortgage example, you originally pay $993 a month. If you’re putting an extra $500 towards your mortgage to pay it off early, that’s $1,493 each month. What is that doing to your personal economy?
If you are determined to pay off your mortgage early, it’s important to look at the cash flow consequences.
The reality may be that you’re unable to spare an extra $500 from your monthly budget and meet your other financial goals.
Or, what happens if times are tight and you end up turning to credit cards or other higher-interest debt to smooth things over?
Instead of paying off your mortgage in about half the time, you might need to reduce the amount of your payment so you pay off the mortgage only 10 years or five years early.
Additionally, your interest savings will be smaller the longer you take to pay off your mortgage.
Some homeowners choose to put what they can towards early mortgage payoff and increase it as their budgets allow. This can be one way to get rid of your mortgage early without straining your pocketbook.
However, it’s important to weigh other financial goals as you decide how much to put towards your mortgage each month. For example, will paying off your mortgage early reduce what you can invest for retirement or your child’s education?
At the end of the day, you only have so much cash flow each month. Therefore, prioritize what matters most to you. Maybe o paying off the mortgage early doesn’t make sense in the long-run.
How well will you sleep at night?
Sometimes it’s not about the numbers. Instead, consider perhaps how well you will sleep at night with your current debt situation.
Personally, I’m comfortable maintaining my student loan debt. And when I had a mortgage, I refused to make plans to pay it off early.
For some people, though, being debt free is a big deal. Getting rid of all obligations, no matter how inexpensive, is preferable to worrying about being in debt.
Think about your own situation and run the numbers. You might be surprised to discover that it doesn’t make sense to pay off your mortgage early after all.