Freedom from debt is arguably one of the best feelings. As homeowners build their savings and investments, many ask if paying off their mortgage early is the right path to financial freedom and stability.
The answer to this question isn't black and white; it varies with each homeowner's savings, investments, retirement, other debts, and overall financial goals. Here are a few things to consider when thinking of paying off your mortgage early.
What Does Your Debt Scenario Look Like?
If you purchased a home in the last few years, it's likely that you secured a mortgage interest rate near historic lows. So if you have other debt, like credit cards, personal loans, student loans, car payments, etc., it's probably best to pay those off before your mortgage.
Those types of loans likely carry a much higher interest rate and are usually "unsecured". A mortgage can be considered "good debt", because it not only helps establish good credit but can appreciate over time, unlike a car.
What Tax Benefits Will You Lose?
Some of the biggest financial perks of homeownership are tax deductions. American homeowners save around $100 million every year by deducting mortgage interest on their tax returns, according to Realtor.com.
Homeowners can deduct up to $1 million in interest payments for a first or second home, as well any points paid to their lender in the year they were paid.
What's Your "Real" Mortgage Interest Rate?
If you have a fixed-rate mortgage at a 4% interest rate, are in the 25% tax bracket and qualify for mortgage interest deductions, your "real" interest rate equates to nearly 3%. Odds are high that you would make more than 3% on investments.
You Still Have Budget Flexibility?
There's nothing wrong with paying off debt in a timely manner, but by paying your mortgage completely off, will you be depleting your savings? Though monthly mortgage payments add up, consider where your money will come from if you experience a job loss, unplanned medical expenses, large expenditures, etc. and you've already spent your nest egg.
What's Your Earn vs. Pay Ratio?
If your effective mortgage interest rate is 3.75% and you can earn 5%+ from your investments, than it doesn't make financial sense to pay off your mortgage. If you can get a higher, more stable return on investments that is a place to consider allocating your money.
What Do Your Investments Look Like?
How much money will you need to carry you to and through retirement? A good rule of thumb is that your investments and savings should be at least double the value of your home (assuming it has been paid off), according to financial advisor Rob Russell.
So it might not be a good idea to pay off your mortgage early if you'll be pulling those funds from your investment portfolio. If your investments are earning more than you're paying in mortgage interest, it's best to keep it put.
As mentioned, there is no right or wrong in paying off a mortgage early, simply what will be putting you in a better financial situation. While paying off your mortgage may give you peace of mind, investing additional funds or paying off other debts could give you a greater sense of financial security while you enjoy the tax benefits of your mortgage.
If you're looking to save money on your mortgage while interest rates are still near historic lows, download our free Refinancing Guide to learn more.