If you’re thinking about paying off your mortgage early, you’re in an enviable position. That’s assuming you are maxing out your retirement savings, have set aside an emergency fund and have found yourself with a sizable chunk of cash available to retire that home loan debt.
Or perhaps you’re considering an accelerated payment plan to knock out that mortgage faster.
Let’s consider the pros and cons of an early mortgage payoff.
Comparing an early mortgage payoff versus keeping the mortgage
|Pay your mortgage off early||Keep the mortgage|
|Less debt increases your monthly cash flow.||If you financed — or refinanced — in the past five years or so, you have a low mortgage rate. In other words, you borrowed historically cheap money.|
|By eliminating interest payments, you gain, in effect, an equivalent risk-free return. That 4% you used to pay to the lender is now 4% back in your pocket.||Investing the money — rather than paying off your mortgage — may give you a higher return, especially in tax-advantaged or tax-free accounts.|
|Because your living overhead is lower, you’ll be able to tap fewer of your retirement assets to meet monthly expenses.||A long-term fixed-rate mortgage is an inflation hedge, with the risk of inflation assumed entirely by the lender. As the cost of living rises, your interest rate stays the same. Over time, the lender receives payments that are less valuable, due to inflation.|
|You lose the mortgage interest deduction, but it’s only worth the amount that you take over and above the standard deduction, which every taxpayer gets.||You keep the mortgage interest deduction, which (slightly) reduces the effective interest rate you pay.|
|You can always tap the value in your home by selling it — or with a cash-out refinance, HELOC or reverse mortgage.||Paying off the mortgage puts value in an illiquid asset — meaning you can’t withdraw it from an account or spend it like cash. Borrowing against it puts you right back where you were: in debt.|
Top tips from financial advisors
Ask financial advisors if you should pay off your mortgage early, and they’ll almost certainly say, “It depends.” That’s because everyone’s circumstances, risk appetite and debt tolerance are different.
If you run into difficult financial circumstances, having a lesser debt burden reduces your break-even for life expenses.
Here are some helpful insights from advisors. See which situations apply to you.
“I happen to think that having an unleveraged asset — that is, a house without a mortgage — is a good thing,” says Chris Chen, a certified financial planner in Waltham, Massachusetts. “If you run into difficult financial circumstances, having a lesser debt burden reduces your break-even for life expenses, such that the impact of a layoff or other adverse financial event will be less painful.”
James Kinney, a CFP in Bridgewater, New Jersey, agrees. “Paying off your home is like investing in a secure, interest-bearing, taxable account paying the rate of your mortgage,” Kinney says. “So if you have a 4.5% mortgage, paying that off is like earning 4.5% in a taxable CD.”
But Kinney says he would want to make sure clients were fully funding their retirement accounts before considering an early mortgage payoff.
Paying off mortgage can be age-based decision
“The younger a person is, the more aggressively they are likely to invest. This weighs strongly in favor of investing rather than paying off the mortgage,” Kinney says. “As a person gets closer to retirement, they begin to invest more conservatively, so paying the mortgage off becomes a more attractive option.”
Kinney believes “there is also a strong emotional attraction” for retirees to enter their life after work without the burden of a monthly mortgage payment.
Early mortgage payoff can have drawbacks
Paying off the mortgage is like investing in an illiquid asset. “You can’t easily tap the funds,” Kinney warns. “It is important you have emergency funds available in an easily accessible account before applying funds to mortgage pay-down.”
One option is to establish a home equity line of credit as a “just in case” financial resource.
Updated Aug. 9, 2017.