Trying To Pay Off Your Mortgage Quickly? 3 Mistakes To Avoid
A home mortgage is likely the largest loan you’ll ever take out, and by a large margin. It’s also no doubt the longest-maturity loan you will have, whether you use the traditional 30-year model or opt for a 15-year mortgage instead.
For these reasons alone, it can seem like a good idea to chip away at that mortgage as fast as you can, both to save on interest costs and to get out from the overhang of having a multi-decade debt. But if you’re trying to pay off your mortgage early, you’ll want to make sure you sidestep some of the landmines that you may encounter along the way. You’ll also want to speak with a financial advisor to see if paying off your mortgage early might actually not be the smartest financial move.
Triggering a Prepayment Penalty
In this day and age, most mortgages are free from prepayment penalties. However, you should never take this for granted.
Always read the fine print of your specific mortgage contract to determine whether or not your lender allows for prepayments. If not, any advantage you get by paying off your mortgage early might be more than overwhelmed by your prepayment penalty.
Prepaying Future Monthly Payments Instead of Reducing Your Principal Balance
If you decide to put extra money towards your mortgage, you’ll usually have to specify exactly where you want that money to go. In other words, don’t assume that just because you include extra money in your monthly mortgage payment that it’s going to pay down your principal.
Some lenders will simply take that money and apply it to your next monthly mortgage payment. Since most mortgage payments have a significant amount of interest in them — particularly early in the life of a loan — you won’t be attacking your principal balance in any significant way. Make sure that your extra principal payments are credited as exactly that — principal payments only, with none being diverted toward interest.
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Putting Yourself Into an Illiquid Position
There’s no point in putting extra money towards your mortgage if your cash flow is already stretched thin. While you may save some significant money paying off your mortgage early in the long run, in the short turn you may be creating a critical cash-flow issue for your budget.
Imagine, for example, that you have a $2,000 mortgage payment and that at the end of a typical month, you have absolutely nothing left in your budget. If you decide you’re going to start paying an additional $1,000 per month towards your mortgage, you might not be able to pay other current bills, or fund your savings or investment plans. In the worst-case scenario, you might even start going into debt.
Always think this through before you start walking down this path. It doesn’t make much sense to start incurring high-interest, nondeductible credit card debt just so you can pay down your lower-rate, potentially tax-deductible mortgage, does it?
Why You Might Not Want To Pay Off Your Mortgage Early
From a strictly financial perspective, there are lots of reasons why paying off your mortgage early might not always be the best option. This is particularly true if you took out a mortgage in 2020 or 2021. During those years, the pandemic — and the Fed — dragged interest rates down to almost nothing. In the mortgage market, rates went as low as 2.65% for a 30-year fixed mortgage, an all-time low.
Even if you waited until 2021 to take out a mortgage, you may very well be sitting on an interest rate below 3%. If you rush to pay off a mortgage with such low interest rates, many financial advisors would suggest you might be making a mistake.
The reason for this is that you must always compare the rate you are paying in interest vs. the rate you could be earning on that money instead. For example, if you have any credit card debt at all, you should be rushing to pay that off first instead of your sub-3% mortgage. This is because the interest on your credit card debt is likely at least 15%, and probably over 20%. If you use your money to pay down a 3% mortgage instead of a 20% credit card, you’re not making the best choice.
Bottom Line
When looking at your mortgage, try to see it as part of your personal financial ecosystem, rather than something that lives in a vacuum. See if the costs involved in paying off your mortgage early outweigh the benefits. Most of all, try to avoid the pitfalls listed above, while paying particular attention to the math when it comes to paying off a low-rate mortgage.
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