Should I pay off my mortgage early?

If you have the extra cash, the thought of paying off your mortgage early might seem like a no-brainer. But is an early mortgage payoff always the right move? Ryan Peters, Wealth Planner with U.S. Bank Private Wealth Management, shares how to determine if it’s right for you to pay off your mortgage or invest extra cash in another way.

The benefits of paying off your mortgage early

Paying off your mortgage comes with some undeniable perks. When you no longer have that monthly payment hanging over your head, you’re likely to benefit from the following:

• Peace of mind. For many people, peace of mind is the number one reason they decide to pay off their mortgage early. “Especially if someone is retired and without steady employment income anymore, if they have the means to pay off their mortgage, it might feel like a weight off their shoulders,” says Peters.
• Saving on interest. Another big draw for people considering an early mortgage payoff is how much they’ll save on interest. By shortening your loan term, you’ll significantly reduce the total amount of interest you pay over the life of a mortgage. If you have a particularly high interest rate on your mortgage, this might be a compelling reason to pay it off early.
• Building equity. The faster you pay down your mortgage, the faster you build equity in your home. “If, down the road, you want to borrow against your home – whether to make home improvements or to pay off high interest debt – you can tap into this additional equity through a home equity loan or line of credit,” Peters says.

By eliminating the cost of your monthly mortgage payments, you’ll also free up funds to invest in other financial goals.

Disadvantages of an early mortgage payoff

Though paying off your mortgage early may seem like a win-win scenario, there can be potential downsides. It’s important to examine any potential penalties or negative financial impacts before taking the leap. These can include:

• Opportunity cost. Peters explains that the biggest potential downside to an early mortgage payoff is what’s called opportunity cost. “If you use extra cash to pay off your mortgage ahead of time, you may miss out on opportunities to invest that money and potentially earn a higher return, especially in a strong market,” he says.
• Reduced liquidity. Making extra payments towards your mortgage naturally means you’ll have less money readily available for emergencies or unexpected expenses. Peters emphasizes the importance of having a solid emergency fund in place before considering an early mortgage payoff (more on this below).
• Credit score impact. It may sound counterintuitive, but paying off any debt in full can cause your credit score to take a hit, and a mortgage is no exception. “When you pay off your mortgage, you simultaneously decrease your credit mix and credit age,” explains Peters, “which may cause your score to drop.” However, this decrease is likely to be minor, and for some, the peace of mind that comes from paying off a mortgage may be more important than this number, especially your score was good in the first place.

What to consider before paying off your mortgage early

Like many financial decisions, deciding whether to pay off your mortgage early is a highly personal choice. Weighing the pros and cons involves knowing what matters most to you, as well as your goals and priorities for the future.

If you’re thinking about paying off your mortgage ahead of time, there are a few questions you should ask yourself first.

• Do I have a solid emergency savings fund? “It’s crucial to make sure you have an emergency fund set up before you consider something like paying off your mortgage,” says Peters. “Financial emergencies can happen to anyone, so ensure you have sufficient cash to cover 3-6 months of living expenses before you consider paying off a mortgage early.”
• What’s my interest rate? Whether or not an early mortgage payoff is right for you may largely depend on the amount of money you can save on interest. The higher the interest rate on your mortgage, the greater the potential for savings from an early payoff. “If you have a high interest rate, then it might be more beneficial to pay down your mortgage,” Peters says. “If you have a rate on the lower end of the spectrum, it might make more sense to invest any extra dollars.”
  Similarly, if you have a high interest rate on your mortgage but carry a balance on a high-interest credit card, it might make more sense to pay off your credit card debt first and retain the mortgage.
• How do I feel about potential tax implications or prepayment penalties? For some homeowners, mortgage interest is a valuable tax deduction. Paying off your mortgage early eliminates this deduction, potentially increasing your tax burden. Depending on the terms of your mortgage, you may also face prepayment penalties.
  “These are usually worked in at the closing of a mortgage,” Peters says, “which is why making sure you’re aware of any potential prepayment penalties prior to closing on your home is important.” Understanding tax implications or prepayment penalties is a wise first step before paying off your mortgage early.

Different methods for paying off a mortgage early

Taking everything mentioned above into consideration, it’s important to note that there’s more than one way to go about paying off your mortgage early. “There are multiple ways you can make extra payments and shorten the length of your loan,” says Peters. “It depends on each person’s circumstances.” Here are a few common approaches:

• Paying it off in full. Paying your entire mortgage off in cash is a big move, but it might make sense if you have the means to do so and are dealing with high interest rates. “If you have enough cash on hand and the opportunity to do it, certainly paying it off in full is an option,” says Peters.
• Extra annual payments. Simply making one extra payment at the end of each year (and applying it to your principal) is another way to reduce the length of the mortgage over time without taking a big financial leap.
• Bi-weekly payments. Peters notes that some people prefer to pay a little additional money towards their mortgage out of each paycheck. Not all lenders offer this option, but it may be a good choice if you want to shorten your loan without taking drastic measures. “There are also third-party service providers that typically charge a small fee upfront and can do this on your behalf,” he says.
• Refinancing. In certain circumstances, you could refinance your mortgage, which can help you pay off your mortgage faster. “Depending on the market and where your rate is, refinancing is an option that can help you decrease the time and overall interest of your loan, such as if you go from a 30-year to a 15-year mortgage,” says Peters.

Alternatives to paying off your mortgage early

If you’ve decided that paying off your mortgage early doesn’t make sense for you, there are still ways you can use extra cash in a way that supports your financial goals. Consider options like contributing more to your retirement accounts, investing through a brokerage account, or contributing to a high-yield savings account for specific savings goals.

“Depending on your age, you may want to contribute more of your earnings to your retirement accounts, such as an IRA or 401(k,” says Peters. “If you’re already contributing the maximum amount allowed, redirecting your additional funds to a brokerage account would diversify and improve your financial outlook in retirement, especially from an income tax perspective.”

You might also contribute to accounts dedicated for savings goals like a college fund for your children or grandchildren. Ultimately, how you choose to leverage extra cash is a highly personal decision and one that will depend on your overall financial situation.

Peters suggests looking at the goals and priorities you want to accomplish later in life and using that to help guide where you put your money.

Only you can answer the question, “Should I pay off my mortgage early?”

Above all, the decision to pay off a mortgage early hinges on your total financial picture. Carefully consider the potential pros and cons, as well as your financial goals and priorities, before deciding if it’s the right path for you. And if you need help, a financial professional can help you create a personalized plan that ensures you’re spending your money in ways that help you lead the life you desire.

“Everyone’s circumstances are different, whether it’s your age, income, or when you purchased your home,” says Peters. “Speaking with a professional can help you create the best plan for your individual needs.

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