If you have the extra cash, paying off your mortgage early may be the responsible thing to do. After all, the thought of being mortgage-free is a great feeling. But is it the right move if your goal is to build wealth?
Financial planner Brian Fry of Safe Landing Financial says everyone’s situation is unique and that it’s essential to understand a household’s financial circumstances before deciding on the best option. But in some cases, paying off your mortgage early isn’t the best choice.
If paying off your mortgage early has been on your mind, Fry shares four things to consider before making that move.
Consider other debts you have, especially credit card debt, that may have a really high interest rate. The average credit card APR was about 16.28% in 2020, based on data from the Federal Reserve. This amount is substantially higher than the average mortgage rate.
Before putting extra cash towards your mortgage to pay it off early, clear your high-interest debt. From there, you can decide what to do with your extra cash.
You don’t want to end up cash-strapped, so it’s important to have enough in an emergency fund before you start directing extra cash elsewhere.
“Let’s say they’re within a year of retirement or in retirement, I would recommend having at least a year’s worth of spending saved up. And for someone that’s maybe five years or more away from retirement, I would say more in the three to six months range of having spending saved up,” Fry says.
Putting a majority of your money into your home may leave your future self in a sticky situation in the event you need access to a lump sum of money. You don’t want to end up pulling money out of your brokerage account at a bad time in the market, or taking out a higher-interest loan.
It all depends on what you plan to do with the extra money you’d put towards your mortgage and what the interest rate on your mortgage is, says Fry. If the interest rate on your mortgage is low, such as below 4%, the money you’re thinking of using to pay it down may serve a better purpose elsewhere, like in an investment account.
“Historically, markets have returned about 10% per year. If a household has a 4% interest rate on their mortgage and receives a 10% rate of return [in the market], then they would net about 6% by continuing to hold the mortgage,” Fry told Insider in an email.
However, he also notes that past performance does not guarantee future results with investment returns. It also depends on the type of securities you hold, your risk tolerance, and your financial goals. Regardless, the stock market is volatile and does not offer a consistent rate of return, so there’s always risk involved if you decide to put your additional resources into an investment account.
Additionally, if you have a high interest rate on your mortgage, it could be more beneficial to consider a third option, which is to refinance the mortgage when interest rates are low (as they are right now). Keep in mind this process will also have additional fees associated with it, such as closing costs that can range anywhere between 1.5% to 4% of the remaining mortgage balance.
If you itemize deductions on your taxes, you can deduct home mortgage interest. The tax incentive you receive from having a mortgage may make it more favorable to keep it.
“At the end of the day, we all want the highest rate of return, but it’s also really important to pay less towards taxes and save more money when it comes to paying on taxes. So if we can find ways to lessen that tax burden over time, it can be really beneficial,” Fry says.
Before considering all your options, Fry says you should review the terms of your mortgage. You may find a pre-payment penalty, or that the fees to refinance may be higher than what you could save if you paid off your mortgage early. Each situation is different, and the only way to know the best option is for you is to run the numbers or work with a financial planner who can help you do that.
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