Paying off a mortgage is a vital decision. For some set of people, it is a matter of deciding if they will assign extra money every month to the mortgage. While for another set, it is a matter of deciding to clear off the loan at the same time. The approach “lump sum” becomes an option from a life insurance proceeds or inheritance.
The question points out two critical challenges
First, a mortgage can exhibit some emotional issues. We are sure to feel secured at the thought of being the owner of a home. Ironically, paying off mortgages could really make one less secure financially, if doing so means using up all their available cash.
Second, for most people, the mortgage is certainly one of the many financial priorities. In a few cases, setting these goals as a priority could be easier. We need to tackle a 20% charging credit card before a 4% fixed-rate mortgage.
To resolve issues like this, this article would serve as a guide. We will look at when and why we shouldn’t pay our mortgages early.
This analysis implies a vital assumption. This post assumes explicitly that we are dealing with a fixed rate or a low mortgage. High rate and adjustable mortgages should be generally refinanced to a lower fixed mortgage rate if possible, unless one is making plans to move anytime soon.
Below, we will look into some reasons why we shouldn’t pay off mortgages early.
You Still Have Another Debt
In most cases, the last debt you need to pay off is the mortgage. If you still have other debts, such as home equity lines of credit and second mortgages, they need to be tackled first. The following are examples of a typical debt.
- Credit Card Debt
We all know that paying off debts of credit cards is a significant priority. Even if you benefit from a balance transfer off of 0%, these introductory last only about one year and a half, which is 18 months.
- School Loans
Specifically, for those who have taken advantage of some repayment plan, or refinanced their school loans, there might be no benefit to paying the loan off early. To this effect, it is probably better to pay school loans off before focusing on the mortgages.
- Car Loans
Most of the car loans come with an interest rate which is higher than the current rate of mortgages, although car loan interests are not tax-deductible.
As shown above, a lot of debt can carry interest of 0%, at least for some time. However, in most cases, these deals apply to a short term loan or might be even temporary. To this effect, paying off these loans are mostly significant priorities than the mortgage.
You Are Not Saving A Gross Income Of Up To 20%
Until we are saving a considerable portion of our profit, we should not pay money to the mortgage. We should at least be saving up to 20% of our income at an absolute minimum, before paying money to the mortgage. These savings possibly includes savings to taxable accounts, as well as savings to IRA accounts, and retirement savings to 401k.
You Don’t Have A 1-Year Emergency Fund
One needs to have at least a significant amount of cash in taxable accounts as a rule, to cover up expenses all through the year before paying additional money to the mortgage. While you are working to maximize retirement accounts and paying off debts, a 1-year emergency fund is possibly too rich. However, when you meet all these goals and decide to pay off your mortgage early, one year is a supreme goal.
One important thing to put into consideration is Liquidity. To pay off a mortgage early require a lot of money. While it might seem to be a good plan, you should not pay off your mortgage in a way that makes you spend all your money.
You Are Still Saving Up For A Big Purchase
It is necessary to make sure you address the needs of your future cash. It is not enough to clear off debts and still save before tackling a mortgage. In General, you need to plan to cover important purchases for at the next three years, and five years will be desirable. The following could be examples of such typical big purchases:
- Home remodeling
- Vacations
- Vacations
- Car purchase
- Children’s education
There is no need of putting money in the mortgage, only to face more debts for more significant purchases.
You Are Investing That Extra Money In An Intelligent Way
Once all debts are paid off, having a reasonable emergency fund, having the need of our cash met for about six to ten years, saving 20% of our income at least, and making use of any extra cash to put in the mortgage is definitely a brilliant choice. Moreover, it is at this point that the big debate surfaces – is it better to invest or pay off the mortgage?
However, here, there are vital assumptions. Firstly, we assume that you are investing for the long run, possibly 10 to 20 years. Secondly, we are assuming you are keeping the investment cost to the barest minimum. Thirdly, we are assuming you have a low and fixed-rate mortgage. And finally, we assume that your investment is diversified adequately. Paying 2% to a financial advisor to put your cash in a mutual fund beats the goal of outperforming the rates on your mortgage.
Some people tend to compare the historical returns of the stock market to mortgage rates. If you could presume a long-term return of 6 to 8% from the stock market, investing pays rather than paying off a mortgage at low rates.
Conclusion
Paying off your mortgage early involves no risk on investments, whereas, there are bigger risks in the stock markets, like over more extended period like 10 to 20 years. In the end, comparing a rate between possible investment and your mortgage is not conclusive, but is helpful.
