8 Things You Need to Consider Before Paying Off Your Mortgage

Do you have extra money coming in and are thinking of paying off your mortgage?  Is that really the best decision for you right now?  

Whether it’s due to your excellent budgeting skills or a promotion at work, when you are lucky enough to have extra cash to spend, it may be difficult to decide the best way to use it.

Naturally, you want to get the most bang for your buck.  And if that’s the case, investing that extra money instead of paying off your mortgage may be best.  After all, have your considered the tax benefits you receive by having a mortgage or making extra payments?

And what about your retirement, your emergency fund,  or your debts?  Are those already taken care of?

In actuality, deciding what to do with your extra cash can be a bit more complicated then just deciding which will give you the best return on your money.  

Every situation is different.  Not to mention, investing comes with risk.  In order to make the best decision for you, there are a number of factors you should take into account.

Things to Consider Before Paying Off Your Mortgage

• Your retirement date
• Do you plan on living in the house forever?
• Do you already have a retirement account set up? Are you maxing it out?
• Your other high interest debt
• Whether your emergency fund is fully funded
• How long you've had your mortgage
• Tax Deductions and Inflation

Let’s take a look at some of these factors more in depth below.

Your Retirement Date

Retirement is a big deal and with it, comes many changes.  One of them being a change in income.  More likely than not, you will not be making the same amount of money you made while you were working.  And unfortunately, it is usually much less.

With this sudden decrease in funds, you are going to want to have your debt squared away before you are in retirement and that includes your mortgage.

In this case, paying off your mortgage will give you peace of mind, knowing that there is one less bill to worry about in retirement.  So if you are close to retiring, you may want to consider putting that extra money towards paying off your mortgage.

Will You Stay or Will You Go?

Are you planning on living in your house forever?  If that is the case, you will pay it off eventually so maybe you are thinking to get it over with faster by doubling up on payments.  Then once it’s paid off, you will put that extra money towards investing. 

But that might not be the best plan.

If you are not planning on staying in the house, then there is no real reason to put extra money towards paying it off, as you are just going to sell it later on, hopefully, for a profit.  

Paying it off early could offer peace of mind and one less bill to deal with but that money can more often than not be put to better use elsewhere.  

Especially nowadays with interest rates at an all time low, it makes little financial sense to pay off your mortgage early.  Instead, consider investing that money as you will earn much more from your investments than you would get from paying off your mortgage.

Do You Already Have a Retirement Account Set Up?

I am of the mind where you should have a retirement account set up before you even consider buying a house.  So if you do not already have a retirement account set up and funded (preferably maxing it out, if it's a Roth IRA, or getting your company match if it's a 401k), I’d give paying extra on a mortgage a hard pass.

Setting up a retirement account early gives your money time to compound and grow tax-free.  More so than regularly investing in a taxable account, investing in a retirement account will give your money an extra boost, as it won’t be weighed down by taxes. 

So take advantage of it as soon as you can. The younger the better.

If you are like me and started saving for retirement a wee bit late then the current limits on one account may not be enough for you.  You may want to consider opening additional retirement accounts if the one you have now is not sufficient.  

I’d say its better to err on the side of having too much money than not enough in retirement.

If you do have a retirement account set up and funded, then you can consider putting more money towards your mortgage.  Check first that, at your current savings rate, you will have enough for retirement. 

Also, make sure that there are no penalties for paying your mortgage off early.

Do You Have Other High Interest Debt?

If you still have high interest credit card debt or student loans, you should be more concerned about paying these off than paying extra on your mortgage. 

Sure the amount of interest you are paying on your house is probably more than any other debt, but with the interest rate being so low you will get a better return on your money by paying off the higher debt.

Not to mention, paying off your credit card debt and student loans will free up your money faster so you can put it to better use such as investing for your future or ensuring you always have a roof over your head.

However, there is an order to investing your money correctly, which I go over a bit in a post about what you should do with your savings.  

Essentially, if your company offers an employer match, you will want to invest in this first and foremost before paying off any debt, as it is a guaranteed 100% return on your money.

Your Emergency Fund

I’m a firm believer in having at least a minimalist emergency fund started before you start paying off debt and investing.  However, once you have a mortgage, your minimalist fund cannot be so minimalist anymore.  

You are going to need at least 3 months of mortgage payments in addition to your other essential expenses in your emergency fund.  

(Update: Considering the recent pandemic, you may want to consider having 6 months to a year's worth saved up)

With life, you never know what will happen, so it is better to be prepared. If you do not have a nicely cushioned emergency fund, I wouldn't be doubling up payments on my mortgage just yet.  First, fully fund that emergency fund. 

Note, that this is after getting that employer match. That’s free money honey! 😉

How Long Have You Had Your Mortgage?

It is said that banks make their money on mortgage loans by collecting all of their interest and fees up front.  But this is a wee bit misleading.  

It is not that they are purposefully adding extra interest costs into your beginning payments, it is just that the amount of interest you pay is based on your principle.

So, in the beginning, when your principle is the greatest, your interest will be high.  Consequently, most of your earlier monthly payments will be going to interest.  But as you pay down the principle, the interest you pay becomes less and less.  

Therefore, if you have had your mortgage for a long time, there may not be much value in doubling up payments, as most payments at this point will be going towards the principle and not to interest.

However, if it is pretty early on in your mortgage payments, you can save tens of thousands of dollars in interest just by paying an extra couple hundred dollars a month.

Tax Considerations

Even though paying all that interest on your mortgage sucks, it is good to know that the government will give you a tax break on it.  Mortgage interest payments are tax deductible.  So, they can decrease your tax bill and save you some money. 

If you look at it another way, you will see that having this deduction makes the actual interest rate for your mortgage much lower. 

For instance, if you have a $200,000 30-year mortgage with a 4.5% interest rate, you will pay almost $9,000 in interest in the first year.  That $9,000 can be deducted from your taxable income. 

If you are in the 22% tax bracket, this will save you about $1,980 in taxes.  Which means you are only paying about $7,000 in interest. 

So, essentially, the interest rate that you are actually paying on your mortgage is about 3.51%.  Suddenly, your interest rate is not looking quite so bad.

Keep in mind though that this deduction is only good for mortgages with a principle of no more than $750,000 and it must be for a personal residence (vacation and second homes included). 

Furthermore, this is an itemized deduction so if you do not itemize you cannot get it.  So check to see if it is worth it to itemize. 

Inflation

A hundred dollars today is worth more than a hundred dollars next year.  And you can thank inflation for that.  We all know about inflation but we don't put that knowledge to much use especially when it has to do paying the bills.

For most people with mortgages, you are paying a fixed rate per month for a specific number of years. Over time, the actual amount you are paying will be worth less due to inflation, which averages a little over 2% a year.  

So instead of worrying about those future payments, which will be worth less than the money today, I think your time and extra money would be better served by investing.  You can use the money you have now, invest, and make that money grow instead of shrink.

All in All

There are many things to consider when deciding whether to use your extra cash to pay off your mortgage or not.  You must consider your overall financials goals and whether the decision you make is inline with them.  

Just be sure that if you are not putting that extra money towards paying off your mortgage you are putting it to good use by investing it, paying off other high interest debt, or building your emergency fund.  

Of course, before you start investing in the stock market make sure you learn more about what investment options are out there.  Investing comes with risks so make sure you know enough to make educated decisions.