Most homeowners want to own their homes free and clear. For some, that means using a raise, inheritance or savings to pay off their mortgage early. But this seemingly responsible move may not always be in your best financial interest.
According to some lenders, paying off your mortgage early actually comes with a cost. Hence, ensure the amount you’ll save in interest won’t exceed what you would earn in other long-term investments, such as stocks and real estate.
Additionally, for investments to make more sense than paying off a mortgage early, the annualized rate of return over a certain number of years would only need to make more than the mortgage interest.
Furthermore, once you are comfortable in your dream home materially and financially, you may consider paying your mortgage off early. But are you sure this is the best financial strategy for you?
So, Should You Pay It Off Early?
This decision depends on the homeowner’s financial situation. Firstly it’s advised to look at how much money you currently have saved.
Moreover, everyone should have an emergency fund, which may be six months of living expenses in case something happens to the breadwinner or winners. If you have no money saved, do not pay off your mortgage early. Start a savings account and do not touch it until you have an emergency fund built up.
Homeowners should think about whether they will get a better return on investment somewhere else or if they should secure the guaranteed return of the home and avoid future interest costs.
One factor is how long a homeowner intends to own the property — if they plan on selling next year, then they should put their money elsewhere. If they plan to hold the property for another 20 years (whether as an occupant or eventual landlord), they should consider paying it off early. It also matters how much the interest rate is.
Advantages and Disadvantages of a pay off
There are several advantages and disadvantages to you paying mortgage early:
Advantages
- More equity. When a mortgage is paid off early, you’ll gain more equity. This gain in equity can provide a sort of financial safety cushion. The equity can also be used later to trade up for a bigger and better home.
- Avoiding interest costs. By paying off a mortgage faster, you can avoid a disproportionate amount of interest costs. By paying the balance sooner rather than later, you can avoid the initial period. Where almost all of the monthly payment goes toward interest and reach the stage where the payment goes toward paying the principal balance.
- Peace of mind. The financial advantage most homeowners may dream of when paying off a mortgage is the resulting peace of mind. With no monthly mortgage payments or debt, the homeowner has more financial freedom and less stress.
Disadvantages
- Difficult access to equity. When a mortgage is paid off early, the money cannot simply be taken out if needed. You’ll need to either sell the house, refinance or get a line of credit against the house to access the equity.
- Opportunity cost. The money used to pay off the mortgage could be used elsewhere.
- Additional bills. When a mortgage is paid off early, the responsibility of paying a real estate tax and homeowners insurance falls on you instead of the lender.
Extra Payments
Once you have come to a decision, as well as weighed the advantages and disadvantages, it’s time to plan for the best financial strategy.
You can make extra payments. The best strategy for you depends on how often you are able to make these extra payments.
It’s recommended paying one extra principal payment each year.
That will reduce the term of a 20-year loan to about 10 to 15 years and save hundreds of thousands of shillings in interest. More importantly, build more equity for you. Basically, if you want to pay off early, make sure you label the one extra payment (principal). In addition, call the servicer to let them know not to apply it to next month’s payment, you want this to go directly to reducing the principal.
Some financial advisors recommend making an extra payment each year by arranging bi-weekly payments with the lender.
For example:
If you set the extra payments as half of your normal monthly payment, you’ll end up making an extra payment each year than you would have if paying monthly. Also, you’ll never miss the extra money in their budget. Simply set this up to be automated whenever possible.
The decision to pay off your mortgage early shouldn’t be taken lightly and success won’t happen overnight. Moreover, If you’re in the right place financially, however, paying off your mortgage early can be a great way to build equity, avoid interest costs and gain peace of mind for getting closer to a debt-free life.
