Should You Pay Off Your Mortgage Early? 4 Things to Consider

If you find yourself with enough cash that you’re considering paying off your mortgage early – congratulations! Being able to own your home outright is a significant accomplishment, and doing so sooner than planned can have potential benefits. 

For instance, it could help you:

• Save on interest payments.
• Reduce your monthly expenses and reallocate those dollars toward another financial goal.
• Enjoy peace of mind in knowing you own your home.

1. Do you have an adequate cash reserve and liquidity?

Before putting the extra money you have toward paying off your mortgage early, take a moment to assess your cash reserve and liquidity. Do you have enough for your everyday spending and savings needs?

Check to see if your emergency fund is in order. Life can take unexpected turns, and there will be times when you need to tap into your reserve for emergencies. Financial experts generally recommend having enough saved to cover at least three to six months of essential living expenses. 

If your cash reserve is not at the level you’d like it to be, you may want to consider directing your dollars that way first before thinking about paying off your mortgage early. 

This is also a good idea for individuals who value having liquidity or easy access to cash whenever they need it. Having a solid cash reserve can help you avoid a “house rich, cash poor” situation, where most of your wealth is tied up in the house, and you don’t have sufficient funds to meet your everyday money needs.

2. Consider your other financial goals

Do you have other financial goals that require your attention? While paying off your mortgage early can have its potential benefits, it may not make sense for everyone. It’s important to consider the tradeoff or opportunity cost of doing so. Here are some common scenarios to consider.

You have higher-interest debt. If you have credit card debt or personal loans that charge a higher interest rate than your mortgage, you may want to pay those off first. High-interest credit card balances can add up over time and impact your credit score.

You’re falling short on your retirement savings goal. For whatever reason, if you haven’t been able to contribute as much as you’d like, you may want to think about putting your extra cash into your retirement plan(s). Maximizing your contributions can be a smart move, especially if you have a workplace plan that provides an employer match. Also remember, individuals who are age 50 or older may be eligible to make catch-up contributions to select retirement plans.

You have opportunities to invest your money for a potentially higher return. If you have a relatively low mortgage rate, it may be worth it to invest instead and potentially earn a higher return. However, investing involves risk, and returns are not guaranteed (you could even lose money). It’s always a good idea to consult a financial advisor first to understand your investment opportunities and see if it makes sense for your goals.

3. Understand the potential tax implications

Broadly speaking, homeowners who itemize their taxes may deduct their qualified mortgage interest payments on their federal return.

The deduction limit depends, in part, on when you took out the mortgage, the mortgage amount, and how you use the mortgage proceeds. In most cases, you can deduct all of your home mortgage interest if certain criteria are met (see IRS Publication 936 for details).

If you pay off your mortgage, it means losing this potential deduction – which in turn may increase your taxable income. Taxes are a complicated matter, so it’s a good idea to consult a tax advisor to understand the value of your mortgage interest deduction compared to the other potential benefits of paying off your mortgage early.

4. Is there a prepayment penalty?

Depending on the terms of your mortgage, you may incur a prepayment penalty if you pay off your loan early. If your mortgage carries a prepayment penalty, this would’ve been disclosed to you  during the closing of your home.

If you’re unsure whether you’re subject to a penalty, locate your loan paperwork and look for the prepayment clause. Review the terms carefully, as it’s possible that the penalty only applies under certain circumstances – for instance, you’re trying to pay off the mortgage within a certain number of years. 

The cost of the penalty varies from lender to lender. Sometimes it may be a fixed percentage based on your outstanding principal or a few months’ worth of interest. If you have questions about your mortgage terms, contact your lender.