Practically every homeowner fantasizes about the day their house is finally paid off, and they can kiss those mortgage payments goodbye.
However, a whopping 56.2% of Americans have an outstanding mortgage with a rate of 4% or lower.
When your mortgage rate is so low, does it make more sense to pay off your house early or invest that money?
We asked financial experts about the matter.
Pros of paying off the house
Having a low-interest mortgage is a badge of honor for some people, especially after the way rates have so dramatically fluctuated over the past few years. But even if you have a mortgage rate low enough to give you bragging rights, there are still many advantages that come with paying your home off early.
First and foremost is a huge sense of security: Not only are you eliminating a big monthly expense, but you are gaining safety and stability from owning your home outright.
“The emotional relief of owning your home can outweigh any financial advantage,” says Chad Gammon, owner of Custom Fit Financial. “The peace of mind is priceless.”
You can also save big bucks by eliminating all of those interest payments you’d be making if you didn’t pay the loan off.
“Reducing interest payments over the course of the loan is one of the main benefits of paying off a mortgage early,” says Steven Kibbel, a certified financial planner.
To find out how much interest you’d be saving by paying off your loan ahead of time, go to the Realtor.com® mortgage calculator and check out the “loan amortization” feature on the top left.
Another huge advantage of kicking your mortgage to the curb is “freeing up monthly cash to put toward other aspects of your life, such as saving or paying off other debt,” says Odest Riley Jr., a partner at SoCal Premier Property Management in Inglewood, CA.
For example, if your $2,000 mortgage payment is suddenly a thing of the past, you can now allocate that money toward student loans or credit card bills.
Finally, when you invest your money into your home by paying off your mortgage, you don’t have to worry about market volatility like you would if you had invested in stocks, bonds, or crypto instead.
“Using your extra cash to pay off a relatively low-rate mortgage may not give you the highest after-tax return compared to investing it,” explains Laura Adams, host of the “Money Girl” podcast.
But the upside, she says, is getting a guaranteed return—namely, a paid-off house—without the risk or worry that often comes with other investments.
Cons of paying off the house
Although there are many upsides to paying your mortgage in full, there are some downsides, too.
“If you pay off your mortgage, you miss the chance to invest that money, which could potentially earn more,” says banking expert J.D. Koontz. “It all depends on the interest rate on your loan and the potential opportunity.”
For example, if your mortgage interest rate is 3%, but some other opportunity offers 7% returns, you’re giving up a 4% potential gain.
Plus, the second you pay off your house, you automatically lose a big tax deduction.
If you claim the mortgage interest tax deduction, the effective interest rate you’re paying on your mortgage is reduced by approximately 1% on an after-tax basis. (For instance, if your mortgage interest rate is 4%, the after-tax effect could make it seem like you’re paying only 3%.)
“Prepaying lower-rate, tax-deductible debts such as mortgages or home equity loans is typically unwise,” says Adams—because you”ll lose that tax deduction when you do.
Another thing you’ll lose when paying off a low-interest mortgage is, well, the low interest.
“A low-interest mortgage is the cheapest debt you will ever have,” Riley Jr. explains. “In my opinion, it is better to pay the mortgage off slowly and pay down any higher debt you may have incurred instead.”
Some people insist that paying off your mortgage and investing the difference is the smartest thing to do—but “studies show the large majority of Americans who free up income after paying off their mortgage generally just find other liabilities to waste that disposable income on,” Riley Jr. says.
Moreover, while it seems counterintuitive, your credit score could actually go down if you pay off your mortgage early. If your mortgage is one of your few credit accounts, paying it off might reduce your credit mix, which can diminish your credit score. Additionally, a paid-off mortgage might lead to less overall credit activity, which could also negatively affect your score.
Locking up your funds is another downside of wiping out your mortgage debt ahead of schedule.
“If you pay off your low-interest mortgage, you lose liquidity, meaning your money is now tied up in the house,” says Koontz.
So before you pay off your loan, beef up your emergency fund just in case you need it. And before you wipe out your entire mortgage debt, be sure to read the fine print.
“Examine your loan documentation or consult your lender to see if your loan has a prepayment penalty or not,” says Kibbel. “If it does, the advantages of paying off your mortgage early may be diminished or even eliminated.”
To pay off your loan or not to pay it off?
Ultimately, the decision to pay off a low-interest mortgage early or not is highly individualized.
“It depends on your financial goals, risk tolerance, and the current economic environment,” says Kibbel.
It’s a good idea to consult with a financial adviser to weigh your options and determine the best course of action for you.
This post was originally published on www.realtor.com
