Should You Pay Off Your Mortgage Early?

Like many financial planning questions, no clear-cut answer exists to whether or not you should pay off your mortgage early. Rather, there are advantages and disadvantages to both paths. And, depending on your unique personal circumstances, you’ll have to determine what makes the most sense. As such, we’ll use this article to help answer the question: should you pay off your mortgage early?

Specifically, we’ll discuss the following:

• Advantages to Paying Off Your Mortgage Early
• Disadvantages to Paying Off Your Mortgage Early
• Wealth Building vs Stability
• Curtail and Refinance Your Mortgage: A Compromise
• Final Thoughts

Advantages to Paying Off Your Mortgage Early

Advantage 1: Save on Total Interest Payments

One of the central reasons for paying off your mortgage early involves total interest payments. When you borrow money, you need to pay interest for the privilege of using those funds. And, on a 30-year mortgage, those interest payments can add up to tens of thousands of dollars (or more).

For example, assume you have 20 years remaining on what began as a $250,000, 30-year mortgage at 3.5%. If you make each payment on time for the entire 20 years, you’ll pay a total of just under $76,000 in interest during that period. Accordingly, if you have enough cash to pay off your mortgage early, you’ll save that $76,000.

Advantage 2: Improve Monthly Cash Flow 

Additionally, when you pay off your mortgage, you improve your monthly cash flow. For example, assume you have a 30-year, 3.5% mortgage with an original balance of $250,000. The monthly principal and interest payment on that loan totals just under $1,130. If you pay that mortgage off early, you’ll now have an extra $1,130 in cash flow every month.

But, it’s important to note here that, while saving on your mortgage principal and interest, you’ll still need to make the payments related to escrow. That is, mortgage or not, you’ll still need to pay property taxes and homeowner’s insurance. 

Advantage 3: Better Return than Low-yield Savings Account

You can also look at paying off your mortgage early as a form of investment. If you have a 3.5% mortgage, you effectively earn that rate of return on every prepayment you make. That is, you earn 3.5% by not having to pay that amount in interest.

And, as historically low as mortgage rates currently are, the average savings account yield is even lower. For instance, say you have $250,000 sitting in a low-yield savings account. It’s highly likely that these funds are earning more than 1% for you. As such, if you instead use them to pay off your mortgage, you effectively earn a return of 3.5% on those funds – far superior to what any savings account will offer.

Advantage 4: Peace of Mind

This last advantage is less tangible than the above ones. When you have debt – especially hundreds of thousands of dollars in mortgage debt – it can weigh on your peace of mind. Accordingly, paying off a mortgage early can absolutely ease that debt-related stress. Particularly when people approach retirement, the peace of mind afforded by paying off your mortgage can prove the most compelling reason for doing so.  

Disadvantages to Paying Off Your Mortgage Early

Disadvantage 1: Opportunity Cost

The primary disadvantage to paying off your mortgage involves opportunity cost, that is, what you can’t do because you use your cash to pay off a loan. In financial planning terms, paying off a mortgage means you lose the growth potential for alternative investments.

For example, say you have $100,000 remaining on your 3.5% mortgage, and you have that same amount sitting in a bank account. Yes, by paying off your mortgage you reap the above benefits. But, you also lose out on the opportunity to invest that $100,000. From 1926 to the present, the S&P Index (originally 90 stocks and now 500) has generated annual returns approximating 10%. Consequently, by choosing to “invest” in a 3.5% return (i.e. paying off your mortgage) rather than putting that $100,000 in an S&P-tracking index fund, you potentially lose out on 6.5% in potential returns.

Now, it’s important to note that, with a mortgage, you’re guaranteed a return, whereas past stock performance does not guarantee future performance. But, from a historical perspective, given a long enough time horizon, stocks far outperform average 30-year mortgage rates.

Disadvantage 2: Lost Tax Benefits 

While not as compelling as the above opportunity cost argument, paying off your mortgage early also eliminates the associated tax benefits. With an outstanding mortgage, you can deduct the related interest payments. If it’s your primary residence, you can deduct this interest (up to $1 million in primary mortgage debt) via the Mortgage Interest Deduction. If it’s an investment property, you simply deduct the mortgage-related interest as a business expense on your Schedule E.

Regardless of how you deduct your interest payments, paying off your mortgage early eliminates those benefits.

Disadvantage 3: Lost Hedge Against Inflation

Lastly, long-term mortgages provide an outstanding hedge against inflation. When you secure a 30-year mortgage, you lock in the same principal and interest payments for that entire loan term (NOTE: your insurance and property tax escrow payments will increase, though). For instance, say your principal and interest totals $1,000. With inflation, currency devalues. In simple terms, that means $1 ten years from now is worth less than $1 today.

From a mortgage perspective, this means that the $1,000 you’re paying in principal and interest today will be less valuable in the future. Or, put differently, you’ll pay down your mortgage in the future with more inexpensive dollars than today. That same $1,000 will simply be worth less. As a result, paying off your mortgage early eliminates that long-term hedge against inflation. 

Wealth Building vs Stability

Countless personal considerations exist when deciding whether or not to pay off your mortgage early. But, broadly speaking, we can generalize that the decision comes down to two priorities. That is, do you prefer building long-term wealth, or do you want stability and peace of mind?

Let’s use the example of a 30-year, $200,000 mortgage at 3.5%. If you make all 30 years of payments on time, you’ll eventually pay a total of approximately $97,500 in interest. But, let’s now fast forward to the 15-year mark of this mortgage. By that time, you’ll have an outstanding balance of roughly $125,000. The question becomes, are you better off using $125,000 in cash to A) pay off that mortgage, or B) make other long-term investments?

If you pay off the mortgage, you save roughly $36,500 in interest payments over the remaining 15 years of the mortgage. Alternatively, let’s say you invest that $125,000 in an S&P-tracking index, averaging 6% per year (a conservative return over a 15-year period). In this situation, you’ll earn just over $68,000 – $31,500 more than you effectively earn by paying off your mortgage early. And, when you combine this growth with the tax-related savings from your mortgage interest deductions, the returns are even better.

But, as attractive as these hypothetical stock returns are, they are not guaranteed. Accordingly, for homeowners prioritizing stability and peace of mind, the guaranteed 3.5% return from paying off your mortgage may make more sense than the potential 6% (or greater) return from investing those funds in the stock market (or another investment opportunity).   

Curtail and Refinance Your Mortgage: A Compromise

Fortunately, the decision to pay off your mortgage early isn’t an all-or-nothing one. For instance, say you have $200,000 and 20 years remaining on a 3.5% mortgage. And, conveniently, you have $200,000 sitting in your bank account. Yes, you can use that money to pay off your entire mortgage.

But, alternatively, you could curtail – or pay down – a portion of your mortgage, refinance the lower balance, and invest the difference. In this example, you could use $100,000 to curtail the loan then refinance the remaining $100,000 balance into a shorter-term, lower-interest mortgage. In this fashion, you reduce your total interest payments while shortening the repayment period.

And, this compromise also frees up the remaining $100,000 for another investment (e.g. stocks, down payment on an investment property, capital to start a new business, etc.). So long as you can command higher returns than your initial mortgage, you’ll have the benefits of investment growth with these remaining funds. Yes, these investment returns won’t be guaranteed, but by compromising, you reap the benefits of A) paying off your mortgage, and B) investing the remaining funds in higher-return options.

Final Thoughts

As stated, it’s difficult to say with complete certainty whether or not you should pay off your mortgage early. Rather, you need to consider your own unique financial and life situation. However, paying off a mortgage early generally increases your peace of mind, whereas investing those funds elsewhere typically results in greater long-term wealth.

Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.