You just bought your dream home and now you have to deal with a 30-year mortgage. Some people advise you to pay off the mortgage as soon as you can, while other advise against it. Who should you listen to? The following article lists some advantages and disadvantages of paying off your mortgage early.
Benefits
Paying off your mortgage will save you tens, if not hundreds, of thousands of dollars in mortgage interest.
For a $450,000 mortgage with a 30-year fixed rate of 5 percent, your total interest is roughly $420,000. On the other hand, if you pay an additional $200 toward the principal every month, you will pay off your mortgage in 24 years and save almost $76,000 in mortgage interest.
Paying off your mortgage gives you your peace of mind and financial freedom. Once you pay off your mortgage, you can take a lower-income job or work part-time without the fear of losing your home.
Disadvantages
Paying off your mortgage limits your access to cash, i.e. your liquidity. You can use the available cash to pay for education, health care, home improvement, entertainment and travel.
It is possible to obtain cash/credit through a second mortgage or home equity credit line based on your home equity. However, this process takes time, and you might end up with a loan with a higher interest rate than your original mortgage.
Paying off mortgage vs. investing in stock market
Many argue that the available cash can be used to invest in the stock market instead of paying off the mortgage. In the past several decades, on average, investments in the stock market generate a 10 percent annual return. This rate of return is often higher than the interest rate of your mortgage.
It should be noted that if you are not confident in your investing skills, it may be better to use the available cash to pay off your mortgage.
Tax and mortgage
Mortgage interest is tax-deductible. Many argue that paying off your mortgage will reduce your tax benefits. In practice, if you are in the 25 percent tax bracket, you need to pay $1 in interest to get 25 cents back in tax return.
On the other hand, with the tax deduction, you are borrowing at a low interest rate. For instance, if you are in the 25 percent tax bracket, a 5 percent mortgage interest rate is only 4 percent after the tax deduction. This rate is very low and comparable to the inflation rate (which is typically 2 to 3 percent annually).
When you consider paying off the mortgage vs. investing in the stock market or mutual funds, it is important to know that your investment gains are also taxed. Long-term capital gains are taxed at 15 percent, and dividends are taxed at your marginal tax rate.
Expert Insight
Your decision to pay off your mortgage should be based on careful considerations of several factors, including investing skill, financial and job stability, health status, future expenses, inflation rate and current economy.
If you are in your 30s, at the start of your career, it may be wise to maximize your tax-deferred 401k contributions before considering paying off your mortgage.
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