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For generations, making a final mortgage payment has been cause for celebration. But despite the undeniable appeal of paying off your mortgage early, whether you should do so depends on your financial situation. If you're in a position to pay off your mortgage ahead of schedule, there are a few things you'd do well to think about first.
Advantages of Paying Off Your Mortgage Early
The advantages of paying off your mortgage ahead of schedule are fairly obvious:
- Eliminating your mortgage expense could free up a significant amount of your income for other things. A mortgage payment is the largest single monthly outlay for most homeowners. What you'd do with that extra cash each month would be up to you, but depending on circumstances such as your age, the extent of your savings and your personal preferences, you might invest it, stash it in a savings account or travel fund, or use it for home improvements, among many other options.
- Paying off your mortgage early will save you in interest. Charges you'd otherwise be paying over the life of the loan are yours to keep and use for other things.
What to Consider Before Paying Off Your Mortgage Early
So if you have enough cash on hand to make extra mortgage payments each month (or quarter, or even annually), or if an inheritance or other windfall gives you a chance to pay off your mortgage in full, why wouldn't you? Here are some considerations:
- Have you maxed out your retirement savings?
Before you look to reduce your mortgage debt, make sure you've fully funded any 401(k) plan you have through your employer, plus any personal individual retirement accounts (IRAs). For 2019, you can contribute a maximum of $19,000 to your 401(k), up from $18,500 in 2018, and $6,000 to a personal IRA, up from $5,500 in 2018. If you're over 50, you can increase those contributions by $6,000. The tax advantages of these contributions, along with the potential for long-term growth in your retirement investments, make them the first place you should be stowing any windfall you've received.
- Do you have a hefty source of emergency cash?
A house you own free and clear is a significant piece of wealth, but it's not something you can quickly convert to cash in a crisis. Selling a home often takes months, even in a strong housing market. You can secure a home equity loan more quickly, but even that will likely take a few weeks, and it would put you back in debt—possibly at a significantly higher interest rate than you had on your original mortgage. So before you sink a large chunk of cash into settling your mortgage, make sure you've set aside a healthy "rainy day" fund—at least enough to cover six months' worth of household expenses.
If you answered no to either of these questions, you should consider organizing your finances until you can answer yes to both—and before you make it a priority to pay off your mortgage early.
Here are some additional questions you should ask before deciding to complete your mortgage payments ahead of schedule. More than one of these considerations may come into play in any given household, and it may be helpful to consult a financial planner or accountant to help you sort out and prioritize all that apply to you.
- Is there a prepayment penalty on your mortgage?
They are rare in new mortgage contracts, but some older mortgages contain requirements that you must make a balloon payment of several thousand dollars if the loan is paid off ahead of schedule. If your mortgage contains such a prepay penalty clause, you'll want to compare the penalty amount with what you'll save in interest by paying off the loan early to make sure you don't lose out on the deal and to make sure (at the very least) that you don't lose money by triggering a penalty.
- Can you make more by investing your money than you'll save by paying off your mortgage (and do you want to if you can)?
Some financial pros equate paying off your mortgage early to opening a savings account that pays you interest at the rate you borrowed at, for the rest of the loan's lifespan. That's great, but if you got a good rate on your mortgage—as many did when rates were at historic lows following the 2008 market crash—that "return" may be fairly modest compared with what you'd get by putting your cash into stocks or mutual funds. If you're getting close to retirement and already have your nest egg organized, that may not be a big concern. But if you're nearer to the start of your career and working to accumulate retirement wealth, you may want to consider investing your spare cash more aggressively, rather than paying off the mortgage.
- How much do you rely on mortgage interest deductions to offset your federal income tax?
If your total mortgage amount is $750,000 or less, you are eligible to deduct mortgage interest payments on your federal income tax return, so paying off your mortgage early could increase your annual tax bill. The impact on you will depend on your income and tax bracket, how much interest you're currently paying on your mortgage, and what other deductions you may qualify for. Consult with your financial advisor about the tax consequences of paying off your mortgage early, for the current tax year and the years ahead.
What About Your Credit Scores?
There likely won't be any dramatic change in your credit score as a consequence of closing out your mortgage loan. While closing credit card accounts can hurt your credit score (by reducing the total amount available to you to borrow), closing a mortgage has very little effect. Like paid-off student loans and auto loans, a mortgage that's paid in full will remain on your credit reports at the three national credit bureaus (Experian, Equifax and TransUnion) for 10 years as a "closed account in good standing."
At the end of that 10-year period, if you haven't established any new mortgage accounts, your credit scores may diminish slightly as a result of reduced credit mix—the combination of different loan types credit scoring models see as a sign of a well-rounded credit user. But as long as your other credit accounts (credit cards, car loans and the like) are up to date and continue to be paid on time, your score will also tend to have risen over those 10 years, reflecting greater experience as a credit manager. So while there are many factors to consider when deciding about paying your mortgage off early, your credit score need not be one of them.
If you have an opportunity to pay off your mortgage early, congratulations. If you consider that option and its potential consequences carefully, you can make the right decision for your financial future.
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