Take a home mortgage, for example. Many people are content with paying a mortgage for 15 or 30 years, while others are eager to pay off all of their debts, including their mortgage, as soon as possible.
Like most financial decisions, which is “right” is more complicated—and personal—than making just one decision.
Good debt vs. bad debt
Some individuals believe that all debt is “bad,” but this is not necessarily the case. Experts refer to both good debt and bad debt. A mortgage lands squarely in the “good debt” column.
According to Stanley Poorman, a financial advisor with Principal®, “How a loan is secured determines whether it’s good or bad.” “A mortgage has an advantage because it is secured by an asset, your house. Personal loans and credit cards are not. ”.
When it comes to good debt, keep in mind that each payment increases your ownership in the asset—in this case, your home—by a small amount. However, bad debt, such as credit card payments, is owed for items you have already purchased and probably use. For instance, you won’t “own” a pair of jeans any longer.
There is yet another significant distinction between purchasing a home and the majority of goods and services. Frequently, consumers can pay cash for items like clothing or electronics. According to Poorman, “the vast majority of people couldn’t pay cash for a home.” That virtually mandates the need for a mortgage when purchasing a home.
The case for not paying off a mortgage
There are some circumstances in which it might not be worthwhile for you to pay off your mortgage early at this time in your life. Use this guide to help.
| If… | You don’t need to worry about paying off your mortgage because… |
|---|---|
| You have a good interest rate. | Rates are historically low—about 3%. “We may never again in our lifetimes find loans this cheap,” Poorman says. |
| You need to increase your emergency savings. | Paying off a mortgage requires you deplete cash, or liquidity, which may leave you without a cushion. Focus first on saving for unexpected events. |
| You’re building retirement savings. | With interest rates so low, “if you invest the money you wouldve used to pay off your mortgage into a retirement account, your return over the long term may exceed the savings of paying down your mortgage,” Poorman says. |
| You’re getting a decent tax deduction. | If it’s deductible, the mortgage interest may make your effective tax rate even lower. |
| You have other high-interest debt. | Money that “costs” more than your mortgage should get higher priority for early pay off. |
| Your mortgage doesn’t worry you. | If you aren’t stressed by mortgage debt and your budget isn’t stretched by the payment, you may have little reason to pay it off early. |
Tip: If you’re in the fortunate position to be able to pay off a mortgage faster, and the idea works for your finances, consider moving to an every-other week payment schedule, round up the total you pay, or make one extra payment per year.
The case for paying off a mortgage
Use this information to help you decide if paying off your mortgage debt is important to you.
| If… | You might want to pay off your mortgage early because… |
|---|---|
| You have a high mortgage interest rate. | If you’re paying more than the current rate and can’t refinance, a mortgage payoff may make more sense. |
| You have adequate emergency savings and insurance. | “Catastrophic things happen all the time,” Poorman says. Paying off a mortgage adds another layer of cushion to your protection plans. |
| Your retirement is fully funded. | Those extra savings aren’t needed elsewhere. Use our retirement wellness planner to gauge your progress. |
| Your mortgage interest deduction doesn’t significantly affect your tax return. | If you have a low mortgage balance, you may be gaining little to make a tax difference. |
| You have little or no other debt. | Lack of competition in interest rates and debt totals makes it easier to focus on faster mortgage repayment. |
| You’re close to retirement. | Eliminating a mortgage can free up cash flow for wants and needs after you’ve stopped working (and may enable you to draw down retirement savings less quickly). |
| You dream about being mortgage free. | Debt can be emotional. “What do you want to achieve?” Poorman says. “That’s the question to ask yourself. If a mortgage is a weight on your shoulders, you can prioritize it.” |
In the end, whether you decide to keep your mortgage or pay it off depends on your personal financial situation and sense of security.
“You’re working hard,” Poorman says. “It’s about you and what you want. ”.
Legal documents and specific objectives can help you make the most of this asset by incorporating your home into your estate plan.
Ask for help. Uncertain of how a mortgage will fit into your overall financial strategy? A financial expert will walk you through the following steps. Check with your HR department or employer to see if your company’s retirement savings plan provides this service if you don’t already have one. Or, we can help you find one.
The information provided by the Retirement Wellness Planner and Retirement Wellness Score is only based on the inputs and other financial assumptions; no financial plan or investment advice from any Principal Financial Group® company or the plan sponsor is intended. Only education is offered by this calculator, which may be useful when making decisions regarding one’s own finances. Participant, not the sponsor of the plan or any member of Principal®, shall be responsible for such decisions. Individual results will vary. Participants should regularly review their savings progress and post-retirement needs.
The information in this communication is provided solely for educational purposes, and it is understood that Principal® is not providing any legal, accounting, investment, or tax advice. On all issues relating to legal, tax, investment, or accounting obligations and requirements, you should consult with appropriate counsel or other financial professionals.
Principal Life Insurance Company provides insurance items and plan management services. Securities offered through Principal Securities, Inc. , 800-547-7754, member SIPC and/or independent broker-dealers. Investment advisory products offered through Principal Advised Services, LLC. Members of the Principal Financial Group®, located in Des Moines, Iowa 50392, include Principal Life, Principal Securities, and Principal Advised Services.
FAQ
Are there tax implications for paying off mortgage early?
An effective way to increase monthly cash flow and pay less interest is to pay off your mortgage early. However, you won’t be able to deduct your mortgage interest from your taxes, and investing would probably be more profitable. Think about how you would use the extra money each month before making your choice.
What are 2 cons for paying off your mortgage early?
- You Lose Liquidity Paying Off a Mortgage. …
- You Lose Access to Tax Deductions on Interest Payments. …
- You Could Get a Small Knock on Your Credit Score.
- You Cannot Put The Money Towards Other Investments. …
- You might find it difficult to contribute as much to a retirement account.
What happens to taxes when you pay off your mortgage?
The interest paid on a mortgage is tax-deductible. You won’t be paying interest once your mortgage is paid off, so you won’t be able to use this tax deduction. Your taxes will increase as a result of the loss of the mortgage interest deduction.
Why do you get penalized for paying off mortgage early?
In essence, when you pay off your mortgage early, the lender loses money. In order to make up for their lost profits, some lenders impose a prepayment penalty. Prepayment fines may be calculated as a percentage of the total amount of the mortgage loan or as a certain number of interest payments.