This is a question common with most people with a mortgage on their home. They wonder whether it is worthwhile to settle their mortgage ahead of schedule. Living debt-free is a great achievement for anyone and it all depends on your position in life, it could be within your reach. But even if it is possible for you to pay off your mortgage early, is it a good move? Though you might find it tempting, I would advise you first take into consideration the opportunity cost of settling off your mortgage ahead of schedule at the expense of other investments or goals to be achieved as well as the impact created on your tax situation.
- Opportunity cost: By considering settling your mortgage ahead of time could be a perfect idea as you have the chance to save the additional expenses on the interest that could be incurred while following the regular payments. This could be a significant saving that would increase along with the prepayment amount. On the other hand, directing more cash on paying your mortgage means those funds are no longer available for investment. Being free from debt at an early stage is the less you stand to benefit.
So how can you be sure whether it is best for you to pay off your mortgage early or invest excess cash? Let’s work with the following examples:
Just in case you had a mortgage with an interest rate of 4% and are already in the 28% federal income bracket. You should have a roughly 2.9% for your after-tax mortgage rate which could be lower if you deduct the mortgage interest on your state income tax return. Investment portfolios for most investors are channeled through a risk tolerance that carries a much higher annualized expected investment return than 2.0%.
Some people will find the “guaranteed” 2.9% to be more attractive than a higher expected market return which leads to a higher unpredictability and risk. For those having a much higher after-tax mortgage rate, they find paying off a mortgage ahead of schedule a much greater option.
You need to take into consideration the following in order to make a more informed decision.
- Taxes: The ability to get mortgage rates deducted is considered the key to tax strategy for many. Consider if deduction itemization would still be possible without mortgage interest.
- Investing: Think of where the cash used to pay off your mortgage would have been directed to.
- Other needs: Think of other needs apart of investing excess cash, do you have any other pressing issues to be handled? Check out your whole financial condition including credit card, student loans, and if you have enough budget to handle emergency situations.
In the end, every situation is different and you are going to have to make the decision yourself to pay off early or not.