There are a ton of videos here on youtube about how to pay your mortgage off early or quickly. The big question I pose to all of these videos that we’re going over today is does it actually make financial sense to pay your mortgage off early?
Sure, the idea of not having any kind of housing payment sounds enticing, freeing, liberating, but from a pure number perspective there are some things to consider if you’re thinking about trying to accelerate your mortgage payment by making extra payments or even if you ran into some cash and are able to pay it off in one big lump sum.
Paying off your mortgage early. Isn’t that part of the American dream? To have a house you own free and clear? To be able to live in a home and have zero payments necessary on it month after month after month? Well, before we even get into the numbers and analyzing if this even makes any sense let’s get something out of the way
The Zero Dollar Myth
There is no such thing as having a zero dollar payment on a house you own in America. You will always have property tax and you should, and when I say should it is very very very very recommended that you have insurance.
In fact, if your house is paid off in full my recommendation would be to have MORE insurance than you would normally have. After all, most insurance policies don’t cover certain things like earthquake, or certain types of floods or negligence, and if you have a house paid in full and there isn’t a bank who has a vested interest in making sure your house is going to get repaired – because they have a loan on the property – then you’re completely on your own if something G-d forbid happens. There’s no big bank who is going to help you fight the insurance company, no adjuster, no consultant – if you have a cheap policy that only covers acts of God then you’re going to be on the hook repairing your house and it can literally bankrupt you.
So even if you were to pay off your mortgage keep in mind that both the property tax and the insurance on your property are still going to be significant payments that you’re going to have to make either every year or monthly depending on the payment plan you arrange.
Let’s Break Down The Numbers
Okay, I promised we were going to break down the numbers and that’s exactly what we’re going to do right now. Let’s take an actual example for a moment so that we can really wrap our heads around what it means to pay off your mortgage early. Now, again, because your property tax and insurance are going to stay in place, we’re only going to be dealing with the principal and interest on a loan.
Let’s say you had a $300,000 loan on a house that you’ve been paying for quite some time and you’ve been able to pay off about half of it….so you only owe $150,000 on that initial $300,000 you borrowed. And let’s say that your mortgage was at 4% just to use a pretty standard number that I’ve seen a lot of people have on their mortgage.
Now if you are new to mortgages you might not realize this but most of your payment is interest when you start a loan. There’s something called a mortgage schedule that you can look up online for just about any mortgage scenario that will break down what portion of your payment is interest which is the bank’s profit vs. what portion of your payment is principal – paying back that initial amount you borrowed.
And while your full principal and interest payment is fixed every month, literally not changing by a penny for 30 years on a typical loan, the amount of that payment that is interest vs. the amount that’s principal literally changes every month.
So in our example a $300,000 loan at 4% – your monthly payment is going to be $1,432.25. Now the first month you pay that a full $1,000 of that fourteen thirty two is interest, and the remaining four thirty two and twenty five cents is what’s going towards your principal. So nearly two thirds of your payment is going towards interest.
Compare that to your last payment if you were to keep the loan for thirty years…and that payment of fourteen thirty two twenty five again hasn’t changed a penny, but now your three hundred and sixtieth payment – the last payment on a thirty year loan – of that only four dollars and seventy six cents of it is going towards your interest and the rest is principal. So you see there’s a huge favor to pay the bank it’s profit first.
Why I am bringing this up – well, in our example, if you only owe $150,000 on a $300,000 loan, you might think that you’re fifteen years in, but that’s not the case. You’d actually be 230 months into the loan which is a little over 19 years in. And it’s crucial to know how many months you have left on a loan if you’re planning on paying it off in order to make an accurate calculation of how much you’ll actually be saving. There’s no easy way to figure this out, I use different software and apps but if you look up mortgage schedule you’ll literally get a month by month break down from month 1 to month 360 if you’re trying to figure this out.
Now with that month number we can start doing some math.
We know that the loan is 360 months and you’ve already paid on 230 of them so we have 130 months left on the loan. A hundred thirty times the monthly payment of fourteen thirty two twenty five gives us a total of one hundred eighty six thousand one hundred and ninety two dollars and fifty cents.
Essentially, it’s going to cost you $150,000 cash today to save just over $36,000 over the next 10 years.
To put that in perspective, if you were to take that $150,000 and put it in an interest bearing account that only had a payoff of 2.5% and keep it there for ten years you would make over $42,000 on your money instead of the $36,000 that you’d be saving on your 4% mortgage…and that’s the main reason why paying off your mortgage early just doesn’t make financial sense.
As long as you don’t have a crazy high mortgage you can almost always find a way to invest the money in a stable market that will yield more returns than you can get by paying it off.
The other way to look at this is not that you have no housing payment every month. We already talked about property tax and insurance and we didn’t even touch on power, gas, internet, pool guy, gardener – HOA – whatever…the right way to look at this is HOW MUCH are you saving every month. And the answer to that is simpler you’re saving fourteen thirty two and twenty five cents every month.
So the question becomes what is going to make a bigger impact on your lifestyle – cause after all your lifestyle revolves around your budget. So is having a little under $1,500 in payment every month going to have a bigger impact on you ORRRR is having $150,000 less in the bank going to have a bigger impact on you? It’s pretty clear to see that parting with a huge chunk like that is a lot more painful than shelling out fifteen hundred bucks a month.
Let’s not forget about taxes either. On your mortgage payment whatever portion is interest is actually a write-off on your taxes. So depending on where your income is coming from, if you need the write off or can use the write off, that portion of your mortgage that’s interest is something that can be looked as a free money when it comes time to do your taxes, and in fact, this is one of the main reasons why it makes sense to refinance your loan back into a 30 year loan when you’re 10 or twenty years into it because of the huge tax benefits in recasting your loan from the start where the interest is higher than your principal.
Does it ever make sense to pay off your mortgage loan?
I can only think of three situations where paying off your mortgage makes sense if I’m being completely honest.
#1 – you’re independently wealthy and just the time it takes in paying your mortgage is annoying so you’d rather just not have a bill to deal with. Chances are if you’re watching this video that’s not you – and I can definitely tell you that’s not me either.
#2 – Retirement. Now this only makes sense if you’re close to the end of your loan term anyways…if you only have a few years left and you want to get rid of your mortgage because you’re going to be on a fixed income in your retirement years I can see that making sense, but again, if you have a hefty six figure price tag attached to your mortgage, I would say you might be better off refinancing and pulling out cash so you can travel or have an easier time with bills. In fact, that’s why the reverse mortgage was invented because people who retire have a hard time paying their bills when they retire and having no mortgage doesn’t completely solve that issue since there are still food bills, car bills, and other stuff they have to pay for.
#3 – if you’re gifting the house to someone. If you own many properties or even if you only own one and you’re planning on gifting it to someone after you pass or just because you’re that flush with cash that you can literally pay for someone’s house than yes, paying off a mortgage makes sense. And if that’s you and you’re looking to give away one of your houses to a nice person who will take care of it give me a call, I’ll be sure to keep it super clean for you.
Other than those three situations I actually think that paying off your mortgage early is a pretty ridiculous thing to do if you have a low interest rate. Mortgages tend to be some of the cheapest loans you can get and often times people will refinance their house and pull cash out of the equity they’ve built in the home to pay off student loans, credit card debt or other things that have a MUCH higher interest rate than your mortgage does.