Paying Off Your Mortgage Early: Should You Do It?
The vast majority of mortgage loans in the United States are 30-year arrangements, allowing people to take ownership of homes immediately and spend three decades paying for them. However, this trade-off is an expensive one. For a mortgage loan that lasts 30 years and comes with a 6 percent interest rate, you will end up paying more than double the original amount of the loan. To avoid the expensive prospect of borrowing money in this way, some people opt to try to pay off their mortgages early. This especially becomes an issue when borrowers' financial positions improve significantly a few years after signing their mortgage loan agreements. However, in considering an early payoff, there is not necessarily one correct answer. There are several things to consider when it comes to deciding whether or not an early mortgage payoff is right for you.
Time Value Of Money: Interest Vs. Inflation
One of the first principles that business students learn is that time is money. This is why lenders can charge interest for the time it takes you to repay your mortgage loan. However, what your loan is costing you in interest may not be as much as you think. For instance, if the market is expected to show inflation rates that exceed your interest rates, you would actually lose money by paying off your debt to avoid interest payments. While such situations are rare, they do happen. This disadvantage of paying off your mortgage early is particularly true if you are a savvy investor or entrepreneur with some golden prospects just ahead. If you are able to take your $50,000 stash and invest it in such a way that you can enjoy a 50 or 100 percent return over the next year, it makes little sense to pay it all toward your mortgage for the purpose of avoiding that 6 or 7 percent interest payment. Before deciding to put your extra cash toward paying off your mortgage, consider other possible uses you may have for that cash. If you would otherwise spend it on something you do not need such as an extra fishing boat, paying off your mortgage is probably the best option. However, if you have any capability of investing in a potentially profitable business opportunity, you may want to rethink your mortgage payoff.
Aside from avoiding interest payments, one of the main advantages of paying off your mortgage early is that you can reduce your exposure to risk. Even if you are easily making payments now, there is never a guarantee that you will be able to continue doing so in the future. By taking the money you have – when you have it – and using it to pay off your mortgage, you can create an environment of financial security in which you are not left owing anyone. For many people, this benefit trumps concerns about the time value of money and making the most profitable investments. Profit potential and risk are always opposing concerns for investors and homeowners should look at their mortgage loan payments – and possible payoff sums – as investments. By stretching out payments over time and using the bulk of your cash to make other investments now, you have the ability to earn much more money, but you run the risk of losing everything. By paying off your house now, you can be sure that you will have a place to live even if your income takes a significant hit.
Variable Vs. Fixed Interest Rates
Mortgage loan agreements come in different shapes and sizes. If your mortgage loan has a fixed interest rate, it is easy to calculate the long-term effects of paying off your loan early versus continuing with regular payments according to the agreement. However, if your mortgage loan has a variable interest rate, you have an increased incentive to pay it off early for two reasons. First, since variable rate agreements are designed to protect the lender from market fluctuations, you have little hope of standing to gain from such fluctuations. Second, even if the variable rate may result in lower payments in the future, there is no guarantee there. Those considering mortgage loan payoffs are often looking for financial stability and variable interest rates are diametrically opposed to financial stability, even though their volatility is usually restrained. (To learn more about variable rate mortgages, see The Pros And Cons Of Adjustable Rate Mortgage Loans.)
Renegotiation And Refinancing
If you are considering a mortgage loan payoff because you feel that remaining in your current loan agreement is particularly disadvantageous, there may a third option. If your financial situation has significantly improved since the time the loan was originated – which is usually the case when people are considering a payoff – you may be able to renegotiate the terms of your loan with your lender thereby securing lower interest payments. If your lender is not willing to lower your interest rates, though, you may be able to refinance your mortgage loan with another lender. The other lender will pay off the remaining balance on your loan and agree to take the remaining payments from you at a lower interest rate. (For more information about refinancing your mortgage, see When To Consider Refinancing Your Home Mortgage Loan.)
When it comes to the question of paying off mortgage loans early – whether in a lump sum or by increasing monthly payments – the right answer is usually to do so. It increases financial stability and delivers the peace of mind that comes of knowing that you will not lose your home. However, the right answer for most people is not the right answer for everyone. If you have specific reasons for continuing to make your mortgage loan payments for the duration of the agreement term, this may be the best thing for you. It’s always a good idea to speak with a trusted financial advisor before making a final decision.