Paying off your mortgage and owning your home outright is a major financial goal for most homeowners. Among the numerous benefits of being mortgage-free are the freedom from a major financial obligation and the potential to save thousands of dollars in interest payments.
While paying off your mortgage ahead of time can be advantageous, it may not be your best option. Depending on your financial situation and goals, you may benefit more by staying the course and applying any extra funds toward other goals.
Here are six reasons why you shouldn't pay off your mortgage early.
1. You Could Make Higher Returns Elsewhere
Repaying your mortgage is similar to locking in a return on investment that is close to the interest rate of your loan. So, if you have a mortgage with a 4% interest rate and pay off that mortgage early, you're effectively earning a return of about the same rate (4%) for the remainder of your loan term. Depending on when you pay your mortgage off, that could be as long as 30 years.
Let's say, for example, your mortgage rate is lower than what you may earn with a low-risk investment over a similar period. In that case, you may be better off keeping your mortgage and investing any available funds elsewhere, such as the stock market.
Over a 30-year period from 1992 to 2021, the average rate of return on the stock market was 10.66%, or 8.10%, when adjusted for inflation. During this period, the stock market's average return was significantly higher than most mortgage interest rates, and it even beats late January's average 30-year, fixed-rate mortgage interest rate of 6.13%. Of course, the stock market can be volatile, and your returns will fluctuate higher and lower over the long term.
2. You Should Build an Emergency Fund First
Before you pay off your mortgage, ensure your cash reserves can sustain a financial emergency, such as an unexpected loss of income or an expensive medical bill. It may be challenging to come up with the money to cover an emergency, especially if it happens during times of economic distress when it is harder to secure new loans.
Strengthen your financial footing by building an emergency fund with enough cash to cover at least three to six months of living expenses. Having enough cash on hand can help you survive a financial crisis without racking up credit card charges or taking out loans.
Consider stashing your emergency money in a high-yield savings account that earns significantly more interest than a regular savings account.
3. You Should Pay Off High-Interest Debt First
You may not want to pay off your mortgage early if you have other debts to manage. Credit cards, personal loans and other types of debt usually carry higher interest rates than your mortgage interest rate. Remember, the higher the interest rates, the faster your accounts accrue debt.
Of course, you'll want to do the math to determine which path saves you the most money. Write down the interest rates for all your debt accounts and compare them to your mortgage interest rate. Aim to pay off any debt accounts with interest rates greater than your mortgage rate.
4. You Could Benefit From the Tax Deduction
If one of your financial goals is to lower your tax bill, you may want to avoid paying off your mortgage early. The IRS allows you to deduct the mortgage interest you pay from your taxable income, lowering your tax bill. You can take advantage of that deduction for the life of the loan.
Also, if you zero out your mortgage, you might offset any progress you've made to reduce your tax burden through other vehicles, like funding your retirement account or investing in municipal bonds. But due to the substantial standard deduction increase in 2018, you may not be able to take advantage of the tax deduction unless you itemize your tax return.
5. You Can Enjoy Greater Liquidity
You might think twice about applying additional funds to pay off your home early since doing so could deplete your liquidity. The extra money you dedicate to your house is locked in a non-liquid asset. If you need funds quickly, selling your property and accessing your money could take a long time.
Maintaining adequate liquid assets that you can easily convert into cash without paying penalties or fees is essential. These assets—including your emergency savings fund, stocks, bonds or a tax-advantaged retirement fund—can expand your options when you need money immediately.
Conversely, if all your cash is tied up in your mortgage, you may need to take out a loan or charge a credit card and repay the debt with interest.
6. You Should Sink More Funds into Your Retirement Savings
If you're not maxing out your retirement contributions or you need to make larger catch-up contributions, you may want to apply your extra cash toward your retirement savings. In most cases, your 401(k), individual retirement account (IRA) or other retirement accounts grow tax-deferred until you withdraw funds.
Directing your extra funds towards paying down your mortgage may come with an opportunity cost, particularly if your employer offers a contribution match. If so, that's free money that can compound over time and help to ensure your retirement fund is sufficient when you ultimately need it.
The Bottom Line
There are many valid reasons to pay off your house early. Ultimately, it's a personal decision, and your choice should align with your goals, risk tolerance and values. You may want to eliminate your mortgage early to enjoy peace of mind. If you lose your income or face other challenging circumstances, you know you and your family will always have a place to rest your heads.
Maintaining good credit is another way to open up more financial choices, including getting low-interest car loans, travel reward credit cards and other credit products. Before applying for new credit, check your credit report and credit score for free with Experian to see where you stand. If you notice any discrepancies or fraudulent information on your credit report, you have the right to file a dispute with the applicable credit bureau to get them removed.