6 Reasons Why Paying Off Your Mortgage Early Might Not Be the Best Move

Owning your home outright and being mortgage-free is a dream for many. It signifies financial freedom and the potential to save thousands on interest payments. However, while paying off your mortgage early can be advantageous, it might not always be the best financial decision for everyone. Depending on your individual circumstances and goals, there might be better ways to utilize your extra funds.

Here are six reasons why you might want to reconsider paying off your mortgage early:

1 You Could Earn Higher Returns Elsewhere:

Think of your mortgage repayment as locking in a return on investment roughly equivalent to your loan’s interest rate. So, if your mortgage rate is 4% and you pay it off early, you’re essentially earning a 4% return for the remaining loan term, which could be as long as 30 years.

Now let’s say your mortgage rate is lower than what you could potentially earn with a low-risk investment over a similar period. In that case it might be wiser to keep your mortgage and invest any extra funds elsewhere, like the stock market.

Historically, the stock market has delivered an average return of 10.66% over a 30-year period (1992-2021). Even after adjusting for inflation, the average return stands at a respectable 8.10%. This significantly outperforms most mortgage interest rates, including the current average 30-year fixed-rate mortgage rate of 6.13% (as of late January 2024).

Of course, the stock market is inherently volatile, and your returns will fluctuate over time. However, historically, the market has trended upwards, making it a potentially lucrative option for long-term investments.

2. Building an Emergency Fund Should Be a Priority:

Before diving headfirst into early mortgage payments, ensure you have a robust emergency fund to cushion against unexpected financial blows like job loss or medical emergencies. Without adequate savings, these situations can quickly spiral into debt, especially during economic downturns when securing new loans becomes challenging.

Aim to build an emergency fund that can cover at least three to six months of your living expenses. This will provide a safety net during difficult times, allowing you to navigate financial challenges without resorting to high-interest credit card debt or loans.

Consider keeping your emergency fund in a high-yield savings account that earns significantly more interest than a traditional savings account.

3. Prioritize High-Interest Debt:

If you have other debts like credit cards or personal loans with interest rates exceeding your mortgage rate, tackling those first might be a wiser financial move. High-interest debt accrues rapidly, making it crucial to prioritize its repayment.

Compare the interest rates of all your debt accounts to your mortgage rate. Focus on paying off debts with the highest interest rates first, as this will save you money in the long run.

4. The Tax Deduction Advantage:

If lowering your tax bill is a financial goal, paying off your mortgage early might not be the most strategic move. The IRS allows you to deduct mortgage interest payments from your taxable income, effectively reducing your tax burden. This deduction applies throughout the life of your loan.

Furthermore, eliminating your mortgage could potentially offset progress made in reducing your tax burden through other means, like retirement contributions or investments in municipal bonds. However, due to the significant increase in the standard deduction in 2018, you might not be able to take advantage of the mortgage interest deduction unless you itemize your tax return.

5. Maintaining Liquidity:

Think twice before allocating extra funds towards early mortgage payments, as this can significantly impact your liquidity. The money you dedicate to your house becomes locked in a non-liquid asset. If you need quick access to funds, selling your property and accessing your money could be a lengthy process.

Maintaining adequate liquid assets that you can easily convert into cash without penalties or fees is crucial. These assets, including your emergency savings fund, stocks, bonds, or tax-advantaged retirement accounts, provide options when you need immediate access to funds.

Conversely, if all your cash is tied up in your mortgage, you might be forced to take out a loan or charge a credit card, incurring interest charges and further debt.

6. Prioritize Retirement Savings:

If you haven’t maxed out your retirement contributions or need to make larger catch-up contributions, consider directing your extra funds towards your retirement savings. In most cases, your 401(k), individual retirement account (IRA), or other retirement accounts grow tax-deferred until you withdraw funds.

Prioritizing retirement savings over early mortgage payments can be beneficial, especially if your employer offers a contribution match. This essentially translates to free money that can compound over time, ensuring a comfortable retirement when you finally need it.

The Bottom Line:

While there are compelling reasons to pay off your mortgage early, ultimately, it’s a personal decision that should align with your individual goals, risk tolerance, and values. Some might prioritize the peace of mind that comes with eliminating their mortgage, knowing they have a secure roof over their heads even during challenging times.

Maintaining good credit is another way to open up more financial opportunities, such as securing 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 assess your standing. If you notice any discrepancies or fraudulent information, you have the right to file a dispute with the applicable credit bureau to get them removed.

Remember, there’s no one-size-fits-all approach to financial decisions. Carefully evaluate your options, consider your personal circumstances, and make informed choices that align with your long-term financial goals.