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The thought of paying off a mortgage early may sound appealing—who doesn't want to be freed from those costly monthly payments and spend less on interest? It may be especially tempting to get your mortgage off your plate before retirement.
Paying off a mortgage early isn't ideal for everyone, however, especially if your remaining income could go toward more pressing financial needs or goals. Here's how to determine whether to pay off your mortgage before retirement and how to make it happen.
Should You Pay Off Your Mortgage Before Retirement?
Many think of retirement being an easy-breezy, carefree season of life. Losing your monthly mortgage payment, along with a daily alarm clock, may sound like a dream that will help you enjoy your retirement years. And it can be, for certain homeowners.
Paying off a mortgage early to be free of it by retirement doesn't make sense for everyone. Here are some key reasons why you might want to pay your mortgage off early—and why you might not.
Reasons to Pay Off Your Mortgage Early
- Pay less in interest over the life of the loan. Every mortgage payment includes interest paid to the lender. While the amount decreases over time as your principal balance goes down, the total interest you pay over the life of the loan can be staggering—especially if you have a relatively high interest rate. If you pay off your mortgage early, that means fewer months or years of paying steep interest fees just for the luxury of having a loan.
- Free up income. Once you pay off your mortgage, you no longer owe a monthly principal and interest payment to your bank. While you do still have to pay for property taxes and homeowners insurance, dropping the housing payment can free up significant amounts of cash in your monthly budget for retirement or other expenses.
- Build equity faster. As you pay your mortgage over time, you build equity in your home. The more equity you have, the more ability you have to put it to work, such as through a home equity line of credit (HELOC) or home equity loan.
Reasons Not to Pay Off Your Mortgage Early
- You'll have a tighter budget in the short term. Sure, once your mortgage is paid off, you'll have more money in your bank account each month. But getting to that point early requires larger-than-required or more frequent mortgage payments. This can put a strain on your budget, so it's important to ensure you can weather the short-term tighter budget in exchange for the long-term improved cash flow.
- You're potentially sacrificing other financial goals. If you're throwing all of your extra income toward paying off your mortgage early, you may not have any income left for other savings. For example, you might not be able to contribute much or anything toward retirement accounts, an emergency fund or college savings for your kids. It may not be the best idea to pay your mortgage off early if those extra funds would be more useful elsewhere.
- You'll get better returns from investing. Putting additional money toward your mortgage also means less money to invest elsewhere. Some financial experts believe that extra income is better off invested in the stock market or elsewhere, getting higher returns than you'll save in interest—especially if your mortgage interest rate is reasonable. While paying interest for more years may feel like throwing away money, there's an opportunity cost to putting everything toward your mortgage, and you may still come out ahead over time by investing your other income in the stock market. However, if you're close to retirement, it may not be as much of a concern.
- You'll lose tax benefits. Some mortgage holders can claim a deduction for mortgage interest when filing federal taxes. If you've taken advantage of this deduction at tax time, you may be in for a higher-than-expected tax bill if you pay off your mortgage early and can no longer claim this benefit.
How to Pay Off Your Mortgage Before Retirement
So you want to pay off your mortgage before you reach retirement? Here's how to put your plan into action:
- Crunch the numbers. If you haven't checked it in a while, review your mortgage terms and find out when your loan will be paid off if you stick to the schedule. You may find that you're already set to pay it off before retiring. If you're not, find out how much of your balance would be remaining upon retirement so you know how much needs to be paid early.
- Determine what you can afford. Once you know how much needs to be paid early, you'll need to figure out how you'll make it happen. Review your budget to find out how much additional money you can afford to put toward your mortgage each month, quarter or year. If you're unsure how much you can handle without detracting from your other expenses and goals, it's a great opportunity to meet with a financial advisor to help you come up with a realistic plan.
- Create a plan for additional payments. This could mean paying more than you owe in each mortgage payment, adding extra automatic payments each month, paying biweekly or submitting additional payments when you receive windfalls like tax refunds. Just make sure they're applied toward your principal, as some lenders will not automatically do this. Review your budget to help you decide on a plan that feels doable, and periodically check in to see if your plan needs adjusting.
- Consider refinancing. While refinancing is often used to obtain a lower interest rate, it can also be used to change a mortgage's term. If your current loan is for 30 years, you could refinance for 15 or 20 years. This increases your monthly payment, and it requires new closing costs, but it may result in a lower interest rate—and it means a paid-off mortgage sooner, with less interest paid over the long run. You could also consider recasting your mortgage, which entails making a lump sum payment that lowers your monthly payments but doesn't alter your terms.
Keep an Eye on Your Credit
Regardless of whether you choose to pay your mortgage off on time or early, it's helpful to periodically check your credit for free on Experian. This will give you real-time feedback on how your financial activity impacts your credit and where you can improve.