Should You Pay Off A Mortgage Just Because You Can?

Craig Berry
The Mortgage Reports contributor

Don’t Automatically Pay Off Your Home Loan

Being debt free is a top financial goal for most Americans.

mortgage is the biggest debt most people will ever have. It’s typically one of the largest balances showing on your credit, as well as the largest chunk of your monthly bills.

With that, it makes sense to want to be mortgage-free.

But is paying off your mortgage early always the best financial decision?

Sometimes it is, but for some homeowners, keeping the mortgage yields even bigger benefits.

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Good Versus Bad Debt

According to the Employee Benefit Research Institute, “the percentage of families whose debt payments are excessive relative to their incomes are at or near their highest levels since 1992.”

All debt is not equal. Since most of us cannot live entirely debt-free, it’s important to understand the differences between good debt and bad debt.

Simply put, good debt is an investment that will increase your net worth and help you generate long-term value and/or income.

Good debt also allows you to manage your finances more effectively, to leverage your wealth, to buy items you need and to handle unforeseen emergencies.

Financial experts agree that a mortgage loan is considered good debt because it not only has lower rates than most other debt, in most cases mortgage interest is tax deductible.

For this reason, even the wealthiest individuals who don’t need a loan will often opt for a mortgage when purchasing a home.

A great example of this is Facebook’s founder Mark Zuckerberg. Even at a net-worth of $53 billion, Zuckerberg didn’t pay cash for his recent home purchase.

On the other hand, bad debt is typically incurred to purchase things that arise out of want, rather than need. These items lose value quickly and don’t generate long-term income.

Credit card debt is one of the most common examples of bad debt. Credit card debt is not tax-deductible, and often piles up quicker than most people realize.

Bad debt can also stem from payday loans, expensive vacations, luxury items such as jewelry, and expensive clothes.

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When It’s Smart To Pay Off A Mortgage Early

Paying off your mortgage early could be wise for some.

Not all homeowners can deduct their mortgage interest. Unless there’s a tax break, the actual cost of your mortgage is higher. Paying off your mortgage early could make sense in this case.

For homeowners who pay Private Mortgage Insurance (PMI), it may be wise to pay more than the required mortgage payment amount.

That pays down the loan principal faster and allows the homeowner to cancel PMI sooner.

Generally, lenders charge PMI to homeowners with less than 20 percent equity in their homes. If you don’t have 20% equity, but have all of your other finances in order, it could be wise to make extra principal payments to eliminate your PMI.

Eliminating your PMI will reduce your monthly payments, giving you an immediate return on your investment. Homeowners can then apply the extra savings back towards the principal of the mortgage loan, ultimately paying off their mortgage even faster.

When Retiring Your Mortgage May Be Unwise

No one wants to pay a mortgage any longer than necessary. After all, having an enormous debt looming over you for years on end, racking up interest, is an unsettling feeling.

Before hurrying to pay off your mortgage by applying extra principal, or shortening your mortgage term, it’s important to take a look at your entire financial landscape.

For most people, the following financial questions should be answered before paying off your mortgage:

  • Are you fully funding your retirement accounts?
  • Do you have health insurance, life insurance, and disability insurance?
  • Do you have enough money saved for your child’s college education?
  • Have your student loans, car loans, and credit cards been paid off?
  • Do you have an emergency fund in place?

Only pay off your mortgage if you will be in great financial shape afterward.

Consider Your “Real” Mortgage Rate Factoring The Tax Benefits

It’s telling to look at effective interest rates which factor in the home mortgage interest tax deduction.

If your mortgage interest rate is 4 percent and you’re in the 28 percent federal income tax bracket, your after-tax mortgage rate is approximately 2.9 percent.

That’s a low rate.

Consider investments that will yield a higher return than your effective mortgage interest rate.

If you can earn 5% or more from stocks, an IRA, or 401(k), it doesn’t make financial sense to pay off your mortgage early.

As another example, if you’re in the 25% tax bracket and you’re currently paying $24,000 in mortgage interest per year, that’s a tax break of $6,000 you’d give up by paying off your mortgage.

Always consult with a tax advisor, but carrying a mortgage can have substantial tax benefits.

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When To Refinance Instead Of Paying Off Your Mortgage

A refinance can change the math when deciding to pay off or pay down your mortgage.

A 15-year fixed rate loan locks you into a much lower rate, plus requires extra principal each month. That retires your mortgage in half the time compared to the more popular thirty-year loan.

A refinance with any loan term, though, can lower your interest rate so much that it no longer makes sense to pay off the mortgage.

For instance, a homeowner has a 5% mortgage rate, but current rates are near 4%. A refinance could reduce the cost of having that mortgage enough to justify keeping it.

A mortgage frees up five or six figures in cash with which to invest, accomplish other financial goals, or to save for emergencies. Once you pay off a mortgage, it can be difficult to get that cash back.

A missed payment or unpaid medical bill can drop your credit score. That makes it more expensive — or impossible — to take out a mortgage on the property again.

Before paying off a home loan in full, make sure you will have a significant buffer remaining after you become mortgage free.

What Are Today’s Mortgage Rates?

With mortgage rates still at historic lows, as well as mortgage interest tax deductions, there can be a good argument against paying off your mortgage early.

Analyze the pros and cons of paying off your mortgage early. Ultimately, the decision should be based on your financial goals on your own personal situation.

Get today’s live mortgage rates now. Your social security number isn’t required to get started, and all quotes come with access to your live mortgage credit scores.

Verify your new rate (May 23rd, 2019)