Ought to I Pay Off My Mortgage Early?
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Editor’s Note: This story originally appeared on SmartAsset.com.
Whether you are experiencing a sudden financial windfall or just have cash left in your budget every month, you may be wondering what to do with those extra funds.
One way is to put more money into the home loan. But should you pay off a mortgage early or are there better places to focus your efforts? Here are some important factors to keep in mind. Consider working with a financial advisor when weighing your options.
There are some very good reasons to pay off a mortgage early, be it to top up the monthly payment or to add a lump sum to the amount owed.
Here are some of the benefits of getting your mortgage loan early – some reasons not to do so, and advice on how to make a decision.
You save on interest
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By repaying your home loan early, you save more interest than with a scheduled repayment of the loan.
How much you save will depend on the total amount of principal payments you have made, as well as where in the amortization schedule you make those payments (how early they are included in the loan).
You reduce your cost of living
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Without a monthly mortgage payment, your monthly cost of living will be drastically reduced. The lower your cost of living, the fewer emergency reserves you and your family need to feel financially secure.
You can also retire earlier or with fewer savings if you don’t have to spend that much each month.
They release cash for other purposes
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Once your mortgage is paid off, the money that would be earmarked for a monthly payment can be used for a variety of other purposes. You could:
- Pay off other debts like credit card balances or student loans.
- Increase your pension contributions.
- Put more money into investments.
- Pay for large life expenses, such as your children’s tuition fees.
- Purchase a second home or rental property.
The possibilities are endless and depend only on your goals and the existing financial situation.
Disadvantages of early repayment of a mortgage
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Of course, there are some instances when paying back a mortgage early isn’t the smartest idea. First of all, there are two things to consider.
You can earn more elsewhere
One of the main reasons to hold back on prepaying your mortgage loan is that you can actually make more money with that money elsewhere.
Let’s say you have a $ 50,000 windfall and don’t know what to do with the money. You have a traditional home loan with an interest rate of 2.25%, but your bank offers you a certificate of deposit (CD) with an APY of 3.5%. In that case, the most lucrative option would be to put that money in a CD rather than paying off your mortgage early.
You lose your mortgage interest tax deduction
When it comes to taxes, deducting mortgage interest can save taxpayers hundreds – or even thousands – of dollars a year. If you pay off your mortgage loan early, you will no longer be able to deduct these costs from your taxes and in the process could unexpectedly increase your tax bill.
It is important to consider how much you will save annually, depending on your mortgage loan and your tax bracket. To see how much your taxes can increase from one year to the next (if you lose that deduction), consult a tax advisor.
Questions to ask yourself first
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Before deciding on early repayment, there are a few questions you should ask yourself.
Do I have enough cash?
Liquidity is an important part of financial security. Keeping a portion of your assets in cash that you can access quickly and easily will not only protect you in emergencies, but also ensure that you will always be able to take advantage of financial opportunities. Before you put any extra money into your home mortgage, make sure you have an adequate emergency fund. Also, consider setting aside three to six months of expenses that could make up for a part-time job or a pandemic closing your business.
Am I saving enough for retirement?
If you have not yet exhausted your pension contributions, this can be a worthwhile alternative to paying off your mortgage early. The more you invest (and the sooner you do), the better your chances of successfully funding your retirement years.
Ideally, you should contribute enough to take full advantage of all employer matches on offer. You should also consider depositing enough into any tax-privileged accounts you have, such as a 401 (k) or IRA, to meet your maximum annual contribution threshold.
Could I earn more interest elsewhere?
As mentioned above, if you can earn more in interest, consider putting your extra money somewhere other than your mortgage loan.
In some cases, you may be able to get more from a high yield savings account or CD than you are paying in interest on your home loan. Or you decide that another short-term investment option – like a peer-to-peer lending platform – could make you more money in the long run.
An alternative to early repayment of a mortgage
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If you want to save money on your mortgage loan or get out of debt faster, prepaying the loan is an option. But also the refinancing.
Refinancing your mortgage can be a great alternative to repaying your loan early. With the right refi loan, you can cut your interest rate, shorten your repayment term and even lower your monthly payments all at once. And you can always use your extra money elsewhere!
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A mortgage is a significant monthly expense for many households, and repaying this loan early can help reduce the interest paid and get rid of debt early.
Whether you find extra wiggle room in your budget or experience a financial windfall, there are a few important things to consider before paying off your mortgage early. For some homeowners, it may actually make more sense to get the money to work elsewhere first.
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