To many, becoming debt-free is one of the most rewarding financial accomplishments. As homeowners build their savings and investments, many ask if paying of their mortgage early is the best option on their path to financial freedom and stability. The answer, though, isn’t black and white. It varies based on savings, investments, retirement, debt, and overall financial goals.
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Here’s what you need to ask yourself before deciding to pay off your mortgage early.
What is Your Debt Situation?
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?
Homeowners can deduct up to $1 million in interest payments for a first or second home. American homeowners save around $100 million every year by deducting mortgage interest on their tax returns, according to Realtor.com.
What’s Your “Real” Mortgage Interest Rate?
Let’s say 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” mortgage rate equates to approximately 3%. Odds are high that you would make more than 3% on investments.
Will You Lose Flexibility With Your Budget?
Having no emergency fund is just as scary to some as carrying debt. There’s nothing wrong with paying off debt in a timely manner, but if you choose to pay off your mortgage, will you also drain your savings?
Though monthly mortgage payments add up, take into account 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 Do Your Investments Look Like?
How much money will you need to carry you to and through retirement? Financial Advisor Rob Russell suggests a good rule of thumb is that your investments and savings should be at least double the value of your home.
With that being said, it might not be a good idea to pay off your mortgage early if you’ll be pulling those funds from your savings account or investment portfolio. If your investments are earning more than you’re paying in mortgage interest, it’s best to keep it put.
As previously mentioned, there is no right or wrong in paying off a mortgage early. Though paying off your outstanding mortgage debt may give you peace of mind, investing additional funds or paying off other higher-interest debts could give you a greater sense of financial security while you continue to enjoy the tax benefits of your mortgaged home.
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.