Just about every homeowner has experienced the same sensation at one time or another: The excitement of a home purchase is deflated at the closing table when the closing agent slides over the Truth in Lending Statement that shows just how much money the loan will cost over the term of the loan.
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It is a sinking feeling to see that a $250,000 loan will likely cost in excess of $500,000. To avoid this, many people strive to pay off their loans early. Indeed, one extra mortgage payment a year can make a huge dent in reducing the length and total cost of your loan. Assuming you can, the question still remains: Should you? Saving money seems like a no-brainer, but the answer that is right for you may be more complex.
Don’t Throw Away Money on Prepayment Penalties
Before you can even crunch the numbers to decide if it is right for you, make sure you know what — if any — prepayment penalty you will be accountable for. Depending on the area of the country and the lending institution, you may or may not be liable for paying a penalty on an early payoff. Penalties are wasted money. They are funds that could be doing more productive work. At least if you are making mortgage payments, you get the benefit of tax deductions. You might be able to find a better use of your funds.
Have Savings for Retirement or Cash Cushion
Are you maxing out your retirement investing? If not, it is likely your financial planner will tell you to do this first. Besides the numerous benefits of maxing out retirement account payments, your money may be better suited toward alternative endeavors rather than reducing your mortgage debt payments. By continuing to carry your mortgage debt, you will be able to devote more of your funds to the here and now. You can increase your present-day savings by squirreling away for a cash cushion so that in the case of an unfortunate event in the future (such as illness or job loss), you will not feel the hit as much. If you spent all your extra money reducing your mortgage principal, you may be forced into a situation where you have to refinance to get that money back.
Consider Your Other Debt Payments and Prioritize
If you carry consumer debt from month to month, especially credit card debt, you should first consider using all extra money to reduce those debt payments that have interest rates higher than your mortgage rate. If you start paying back low interest rate loans (mortgages) before high interest rate loans (credit cards), you are leaving money on the table each month. Until your high-rate loans are paid off, it does not even make sense for you to think about an early payoff. Why pay off a principal of a 4.5 percent loan and continue paying interest on a 14.5 percent loan?
Using your mortgage to outlast inflation
Your monthly payment may seem high to you today, but it is likely that in 30 years the same amount will seem like a joke. As inflation rises, keeping your mortgage may actually be a hedge against inflation if you have a fixed-rate loan. Your payments will never increase and over time will actually become “cheaper” comparatively.
Gaining Emotional Freedom
Perhaps the best argument for paying down your mortgage debt is the psychological release you will get in owning your home debt-free. There is a liberating sense of freedom in paying off a loan, especially when that means you now own a piece of property outright. It gives you flexibility, confidence and a method to avoid risk of loss since your dollars have been spent on achieving equity. But this may not be the fastest way at growing your net worth because those dollars are no longer working for you. The funds are tied up in your property and not out there in the world gaining interest.
Just like most decisions in life, there are positives and negatives when deciding whether to pay down your mortgage early. On the one hand, you may have a debt-free asset. On the other, it may not make financial sense. The best advice is to first seek guidance from a financial planner. And then be honest with yourself about your goals. Only you can make the best decision for you.
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JT Ripton is a freelance writer in Tampa who covers a myriad of real estate topics, including personal finance and home improvement.