Should You Pay Your Mortgage Off Early? – Calculator Included!

Should You Pay Your Mortgage Off Early? – Calculator Included!

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For 99.99% of us, buying a home will be the largest purchase of our life. It’s one of the most exciting times in your life and also the scariest. You get to call a place home, decorate it how you want, and just make it yours. Unfortunately, long after you’ve bought your house and made it feel like home, you still have to pay for it through your mortgage. For most, a mortgage is a gorilla on their back and one they want to get rid of as quickly as possible. Is it smart to pay your mortgage off early though?

Should you pay your mortgage off early?

The simple answer is no. Paying off your mortgage early is actually costing you more money in the long run. You should take advantage of the fact that mortgages are cheap, they give you flexibility with your money and allow you to invest in other higher returning options.

People are terrible at managing their debt. But even though your mortgage will most likely be your largest chunk of debt ever, people are surprisingly good at paying it off. More often, things like student loans and credit card debt are the payments that people struggle making payments on. The obvious reason here is that they need a roof over their head.

Because of this need for survival, they prioritize it and try to eliminate it as fast as possible. To be honest, any plan for the regular person to get out of debt is a plan I’m a fan of. But you aren’t a regular person, you’re smart, and I want to teach you the answer to the question; should you pay your mortgage off early?

1) Mortgages Are Cheap

The first reason that I believe people overlook is that mortgages are actually extremely cheap. Think about it like this. What other items can you borrow $100,000+ for and only pay an interest rate of 4-6%?

The answer is NOTHING and that means mortgages are extremely cheap.

This may seem like an apples to oranges comparison but if you get a regular mortgage versus borrowing that same amount on a credit card, the results are a astronomically different. For this example let’s say you borrow $100,000 over 30 years. The mortgage has an interest rate of 5% while the credit card rate is 20%.

Over those 30 years, you are going to pay $93,000 of interest on the mortgage while on the credit card, you’ll pay over $500,000 in interest!

I understand that you can’t borrow that amount of money on a credit card without someone coming and foreclosing/repossessing but you get the example. Mortgages are cheap so take advantage of them while you can.

2) Flexibility With Your Money

It’s a well-known fact that most Americans don’t have the funds to pay an unexpected bill of over $500. The reason for this stretches way outside the scope of this article. It’s an important fact though because there are some of these people using any and all extra cash to pay down their mortgage faster.

You Need An Emergency Fund

While I’m happy these people aren’t wasting their money, I think they could be a little smarter before immediately using it on their mortgage.

I’m a huge fan of emergency funds. I basically give a lecture about them in my book, Young, Dumb, and NOT Broke?!, because I understand the dire need to have one. If you are one of the many Americans who can’t afford a $500 unexpected bill, it’s because you haven’t taken your emergency fund seriously.

Before you plan on making any extra payment to your mortgage you need to make sure you have a well-established emergency fund. I recommend having six months of living expenses saved up and hidden away in a savings account. Remember, this is the minimum. It isn’t out of question to have 12 months or even 24, it just needs to be however much gives you a sense of security.

Money Tied Up In Equity

The other big issue I have involving flexibility is the fact that those extra payments go to equity and do very little for you. People will argue that the more equity you have in your home the better but this just isn’t true.

Betting on equity to give you a better return on your investment is a terrible bet. This is because of a couple of reasons. One is that you can invest your money elsewhere (which I’ll talk about next). The other is that you should bet on the appreciation of the property.

Chances are good that if you own a home, it will go up in value year over year. This may not happen in the short term but it has proven effective over the long run.

For example, I bought a home in 2014 and the appraised value today tells me that the value has increased 6% per year on average. That’s an amount that I can’t probably beat on paying extra to that principal alone so I don’t.

Edelman Financial Services does a great job of illustrating this by this graph:

3) Pay Off Your Other Debt

My third reason to answer the question “should you pay your mortgage off early” is that you need to focus on other debt.

Most people have different forms of debt, whether that is credit cards, student loans, auto loans, or their mortgage. It can be extremely daunting to pay off this debt and the more time you wait, the more interest builds.

It’s a vicious cycle that can literally bankrupt people and cause them to have to start from scratch. Over the last 10-15 years, you have seen a shift in financial education and people wanting to take more control to avoid these situations. This has given rise to people like Dave Ramsey who has developed the debt snowball.

Debt Snowball Technique

The debt snowball is a technique where you pay off your smallest debt first. Then you move on to the next biggest and so on until you are debt free. For most people, this is a good idea. But for smart people who have self-control, it isn’t the most effective.

I like Dave Ramsey and think he can and does help a ton of people but he gets this one wrong. Instead, people need to prioritize based on interest rates rather than the largest or smallest amount.

Prioritize By Interst Rate

When you have a $100,000 mortgage looming over your head, you want to get rid of it as soon as possible. I get that. But if you have $10,000 in credit card debt, $50,000 in student loans, and a $15,000 car loan how do you prioritize?

Here’s the breakdown for these amounts:

So which one do you pay off first?

Side note; no matter which one you choose, you MUST pay the minimum balance on each one. Throughout this whole article, we are talking about where you should put your extra money. It’s never financially responsible to stop making payments at all.

Your mortgage and student loans make up the majority of your debt so this is what most people attack first but they disregard the interest rate. To maximize the amount you are saving, here’s how you should prioritize your extra payments towards principal, strictly based off interest rate.

As you can see, your mortgage is last and this is because it is the cheapest, which we talked about above. (Cheapest meaning that it has the lowest interest rate, so it won’t cost you as much to let it wait.)

4) Mortgages Allow You To Invest

I hinted to this tip above, but having that free cash flow from not paying your mortgage down early is going to allow you to invest. If your emergency fund is full and you are making the payments on all of your other debts then congratulations, you have earned the right to invest.

Most people jump to this step first as it is honestly the most attractive. You see ads of people bragging how they made millions investing and you want in.

Before we go any further, I want you to get that image out of your mind. That’s not how it works and those are just sales pitches.

The investing we’re talking about here is boring and it’s cheap (two things that often lead to financial freedom). Also, unlike those ridiculous ads you see on Facebook or Instagram, this one actually works.

The type of investing I’m talking about is through either a Roth IRA or traditional IRA and it’s by investing in low-cost index funds. This isn’t an article on retirement accounts so if you want to learn more about that, then read my article, Index Funds – Your #1 Option For Your Retirement Account.

The Math

What I do want to get into is the math and show you exactly how much more money you will be making/saving by not paying off your mortgage early.

Let’s say you have $200 extra per month and you want to see if you should put it towards your mortgage or invest it into something like a Roth IRA.

When you put that extra money towards your mortgage principal, you are going to pay if off faster obviously. So to make this comparison fair we’ll say once the mortgage is paid off you’ll take that $200 and then start investing it.

The investment account makes 7% and the mortgage is a 30 year loan on $100,000 at a 4% interest rate. Here’s how the math comes out:

You don’t have to be an economist to figure this one one. If you take that $200 extra per month and put it towards an investment account, you’ll accumulate $112,000 more over a 30 year period. That’s probably a number that gets your attention, and it should.

5) The Interest is Tax Deductible

My last and final reason is for those of you who itemize your taxes. I realize I’m talking to the minority here because as I stated in my article, How Trump’s Tax Plan Affected Me – Did It Lower My Refund?, 94% of people take the standard deduction.

With the rise of the standard deduction, that 94% is going to rise with it but there are still some of you out there who itemize. If you do, then you are well aware that when you itemize, one of the largest deductions is the mortgage interest. This will all depend on your loan amount and interest rate but it’s not unreasonable for a $150,000 home to have a $4,000+ deduction.

This can have a gigantic effect on your tax bill at the end of the year and something you want to keep for as long as possible. Because let’s be real, who likes to pay taxes? Not me.

If you pay down your mortgage as soon as possible, you are limiting the time you can use this deduction. That, in combination with everything else we discussed above, is a losing formula.

Related Questions

How can I pay my mortgage faster?

If you do decide to go the route of paying your mortgage down faster, then you should know there are multiple ways to do this besides just putting extra money towards the principal.

For one, you could switch to bi-weekly payments. By doing this, you are adding an extra full payment into a year. Another way is to refinance to a shorter loan term going from a 30 year to a 15 year.

The last option is putting any lump sums of money you may get directly into your principal. For example, you get a bonus at the end of the year. Instead of going out and buying a new BMW, you put that towards your mortgage.

How does paying down your mortgage affect your taxes?

In the short term, making extra payments towards your principal does not affect your taxes at all. This is because the only thing that is tax deductible in terms of your mortgage is your interest.

In the long term you will pay more in taxes because you won’t have that interest to deduct. This only applies to you if you itemize which we talked about in point 5.

How can I easily compare my mortgage options?

You’re in luck! I have built a tool and a video tutorial that allows you to easily compare different mortgage options.

You can basically do anything you want to do with this calculator and see it in three different scenarios. Adjust the purchase price, the interest rate, or even the loan terms. Additionally, you can compare what would happen if you paid an extra $100 towards the principal or made a lump sum payment of $5,000. The possibilities are endless.

Did I mention it’s free?!?

Here’s a view of the home screen.

If you want the tool then click here. It’s free so why not check it out?

I’ll give you an extra tip here as well. If you like the spreadsheet and learned from the tutorial video then subscribe to the YD&NB YouTube Channel. It’s pretty bare bones now but in a year or so it will be packed with helpful content.

The Bottom Line

At the end of the day, this is all up to you. Debt is terrifying to some and they want to do anything they can to get rid of it. There is nothing wrong with that as long as you are aware of the money you are potentially costing yourself. If this is you then find a way to do exactly that.

Whether it’s Dave Ramsey’s Debt Snowball technique or you want to stick every extra penny towards the principal. Whatever makes you more comfortable is the way to go.

Overall, a balance needs to be struck between your peace of mind and your bank account and that point will be different for all of us. Personally, I love using debt to increase my wealth and have found a way to use it without getting overexposed.

If some people saw my balances they would think I’m crazy, and that’s fine. It’s whatever works for you.

Hopefully I’ve answered your question of whether you should pay your mortgage off early. If you want to learn how to leverage renters to pay your mortgage and house hack, then check out my article, How To Start House Hacking When You’re Under 25.

If you liked this post then please pin the picture below and if you want to read more articles here are my latest:

A mortgage is going to be your biggest piece of debt in your life. Should you pay it off early? Learn here if you should pay your mortgage off early.

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