Prepaying a mortgage can be a financially savvy move for some homeowners. For others, however, it just doesn’t make sense. The bottom line: If you don’t have enough money to cushion your savings before you begin paying off your mortgage early, prepaying your home loan may put you in a financial hole if an emergency arises. To help determine whether prepayment is a good option, realtor.com offers some pros and cons from financial experts.
Pro: You’ll cut down on the interest you owe
Interest is the extra fee you pay your lender for loaning you the cash needed to buy a home. By increasing your monthly mortgage payments—also called “prepaying” your mortgage—you’ll save money on interest charges, and those savings can add up over time.
For example, if you take out a $200,000 mortgage with a 4 percent fixed interest rate and a 30-year term, and you continue to make your minimum monthly payments, you’d be doling out $143,739 in interest over 30 years until the debt is paid. By paying an extra $100 per month, however, you’d pay only $116,702 in interest over a 25-year time span—a savings of $27,037.
Pro: You’ll pay off your mortgage sooner
Accelerating your mortgage payments also shortens the length of time it takes to pay off the loan, which increases your future cash flow…and that’s a huge incentive for some borrowers. Paying more cash toward your mortgage’s principal each month also can give you peace of mind.
Pro: You’ll build equity faster
No matter how much money you put down on your mortgage, your home equity is the current market value of your home minus the amount owed on your loan. If your home is worth $250,000 and your mortgage balance is $200,000, you’d have $50,000, or 20 percent, in home equity. Making larger mortgage payments toward your loan’s principal would enable you to build equity faster, which can be advantageous if you’re looking to get a home equity loan or line of credit to pay for expenses such as home improvements.
Pro: It helps your credit score
Showing that you have less debt—and that you manage your debts responsibly by paying your mortgage off early—can raise your credit score. That can help if you’re thinking about applying for a car loan or a second mortgage on a vacation home since your credit score would affect the interest rate for which you qualify.
Con: Prepaying reduces mortgage interest, which is tax-deductible
Prepaying your mortgage reduces your mortgage interest, so it may not make sense from a tax-savings perspective. Mortgages are structured so you begin by paying more interest than principal. For example, in the first year of a $300,000, 30-year loan at a fixed 4 percent interest rate, you’d be deducting $10,920. Taking a mortgage interest deduction under the new tax law requires itemizing deductions—and itemizing may no longer make sense for many homeowners, since the standard deduction increased under the new tax plan to $12,200 for individuals, $18,350 for heads of household and $24,400 for married couples filing jointly.
In the past, you also could deduct the interest from up to $1 million in mortgage debt (or $500,000 if you filed singly). However, for loans taken out from Dec. 15, 2017, onward, only the interest on the first $750,000 of mortgage debt is deductible.
Con: You could miss out on investment opportunities
Every dollar you put toward your mortgage principal is a dollar you can’t invest in higher-yield ventures, such as stocks, high-yield bonds or real estate investment trusts. That being said, you’d be assuming more risk by investing your money in the stock market, for example, instead of putting the money toward your mortgage. Consider your risk tolerance before deciding where to put your extra cash.
Con: You may miss paying off higher-interest debts
Paying off higher-interest debt—such as from a credit card or private student loan—is more important to some homeowners than prepaying their mortgage. If you’re carrying a $400 debt on a credit card from month to month with a 20 percent interest rate, the amount of money you’re paying in credit card interest is $80 per month—that would be much higher than what you’d be paying in mortgage interest on a home loan with a 4 percent interest rate.
Con: Prepaying a mortgage could hamper achieving other financial goals
Although building retirement savings is important, some people make the mistake of prepaying their mortgage rather than maxing out their retirement contributions. Many financial experts suggest their clients do a full 401(k) match with their employer and build a sufficient emergency fund—typically, a fund large enough to cover three to six months of their essential expenses—before they focus on prepaying their mortgage.
Con: There may penalties for prepaying your mortgage
Some lenders charge a fee if a client’s mortgage is paid in full before the loan term ends. That’s why it’s important to check with your mortgage lender—or look for the term “prepayment disclosure” in your mortgage agreement—to see if there’s a penalty and, if so, how much it is.