January 6th, 2019 10:33 AM by Jackie A. Graves, President
in a monthly mortgage payment can be a hassle and a headache. It's probably
your largest monthly payment, and it likely takes a good chunk out of your
If you're tired
of the bank being a co-owner on your home and want to stop sending in those
payments every month, you may be tempted to try to pay off your mortgage early
by sending in extra payments. Unfortunately, while it seems like a smart
financial move, doing so can actually be a bad idea. Here's why.
1. There's a big opportunity cost to paying off your mortgage
Every dollar you put
toward paying off your mortgage early is a dollar you can't use for anything
else, such as saving up an emergency fund.
If you have no emergency
fund because you put your extra money toward an early mortgage payoff, a single
financial disaster could force you to take out costly loans. Or, if your
mortgage hasn't been paid off in full yet, an emergency could lead
to foreclosure on your house if it means can't pay the mortgage later. While
you could tap into the equity in your home using a home equity loan or line of
credit to cover emergencies, getting these loans can be costly, time-consuming
and you aren't guaranteed to get it.
Another opportunity cost
is losing the chance to invest in the stock market. If you put all your extra
cash toward a mortgage payoff, you're losing the chance to earn higher returns
and benefit from compound growth by investing in the stock market. It's
reasonable to expect around a 7% to 8% return if you invest in the broader
market. Meanwhile, your mortgage rate is probably below 4.5% and may be much
lower, so at most, you're likely getting a 4.5% return on any money you prepay
to your mortgage.
You're better off doing
something with your money that will most likely earn you close to double the
return you'd get from paying off your home loan ahead of schedule. There's no
pressure saying you have to beat your mortgage payment schedule.
2. You'll miss out on tax breaks.
If you itemize your
taxes by taking specific deductions instead of claiming the standard deduction,
you can deduct interest paid on your mortgage.
When you deduct mortgage interest, this reduces your taxable income for the
year, meaning you may pay a less percent of your income in taxes if you fall
into a lower tax bracket.
If you took out
your mortgage before December 15, 2017, you're eligible to deduct the cost of
mortgage interest you pay on up to $1 million in mortgage debt. If you took out
your loan after, you can deduct mortgage interest on up to $750,000 of
You give up that tax
break each year after your mortgage is paid off. Plus, if you're
using money to pay your mortgage that you otherwise could've invested in a
401(k) or IRA, you're also giving up a tax break each year you
could've gotten for retirement savings. And you don't have to itemize to claim
these tax breaks for retirement investments, which means you can claim them
even if you take the standard deduction.
If you spend $5,500
prepaying your mortgage instead of putting it into an IRA, you could miss out
on a $1,210 tax break just from this alone if you're in the 22% tax bracket
since you wouldn't have to pay the 22% tax on the $5,500 in income you
the fact you can earn better returns by investing than by paying off your
mortgage early, some people still prefer to prepay their mortgage. This may be
because of an aversion to debt, or a belief it's better to get the guaranteed
return that comes from mortgage prepayment, since there's no guarantee invested
money will grow.
The problem is,
you need to factor in inflation when deciding if this strategy makes
sense. Due to inflation, your mortgage effectively becomes cheaper to pay
over time since the value of your money erodes but your mortgage payment stays
the same (assuming you have a fixed-rate loan). If you have a monthly payment
of $1,500 today, in 25 years, the $1,500 you'll pay toward your mortgage would
be the equivalent of around $942 of today's dollars -- assuming inflation of 2%
mortgage payment is continually getting cheaper over time, it seldom makes
sense to prepay it. Don't forget that all the interest savings you net from paying
off the mortgage early are also reduced by
inflation, making this even less of a good deal over time. If you save around
$80,000 in interest by paying off a $300,000 4.5% mortgage in 21.5 years
instead of 30 years, you've actually saved less than $50,000 when accounting
for the fact you don't benefit from the interest savings for more than two
you want to make the smartest choice for your money, putting it into the market
and building a diversified portfolio is the way to go.
Over time, you'll likely earn better returns on your money, you will benefit
from years of tax breaks, and the costs of your monthly mortgage payment will
fall thanks to inflation.
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