Should You Prepay Your Home Mortgage?
- Matt Bell SoundMindInvesting.com
- 2014 4 Apr
A home is typically your most expensive asset, largest expense, and most valuable tax deduction. So, all financial decisions related to your home are extremely significant.
When buying, Sound Mind Investing recommends putting at least 20% down so as to avoid having to pay for private mortgage insurance. Keeping the combination of mortgage payment, property taxes, and homeowner's insurance to 25% or less of your monthly gross income is also important. (See Making Sure Your House Doesn't Own You.)
Once a purchase is made, an important follow-up decision is whether to pay off your mortgage ahead of schedule. Here's our advice.
Pay it off at least by the time you retire. More people than ever are carrying a mortgage into their 60s and 70s. Often, this is because they refinanced at some point, restarting the 30-year mortgage clock.
Retirement works better without a mortgage payment! Even if you're planning to move when you retire, plan to have the mortgage paid off by then—in case you end up not moving.
Another word of caution: Many of today's workers expect to work past the typical retirement age of 65, either because they'll need the money or they just want to stay involved in their work. But there's a significant disconnect between this intention to work longer and the actual experience of today's retirees. Many had to retire earlier than intended, often because of health issues. So, even if you don't plan to retire from your job by age 65, plan to retire your mortgage by then.
Put the goal in its proper place. Successful money management requires setting priorities. While paying off a mortgage early is a good idea, other objectives deserve to be higher on your priority list.
If you have any debts other than your mortgage—credit cards, vehicle debt, student loans, etc.—paying these off first and then building a savings reserve should be higher priorities than prepaying your mortgage.
SMI suggests your initial financial priority should be to build an emergency fund that would cover one month's essential living expenses. Your next priority should be paying off all non-mortgage personal debts. At that point, the focus returns to expanding your emergency fund from one month's expenses to three-to-six months' worth.
Even then, prepaying your mortgage may need to wait, depending on your retirement-savings plans (and to a lesser extent, college-savings plans, if applicable). Only when the initial debt and savings goals are met and your retirement-savings plans are underway should you begin prepaying your mortgage. Prepaying has two appealing benefits. (This isn’t necessarily either-or: many people make additional principal payments while also building their retirement savings through regular contributions.)
You'll save money. Let's say you've just taken out a 30-year, $200,000 mortgage at 4.5% interest. If you held that mortgage for the entire 30 years, you'd end up paying $364,813—nearly $165,000 in interest!
But if you added $100 to each payment (ask your mortgage company to apply the extra money to principle), you'd pay off the loan five years early and save nearly $32,000 in interest. The higher the mortgage interest rate, the greater the savings.
You'll gain peace of mind. This benefit of paying off your mortgage early is significant regardless of your interest rate. It's difficult to put a price tag on an emotional factor, but the sense of freedom people experience from not having a mortgage payment is huge. While you'll still be on the hook for property taxes, insurance, and upkeep, being mortgage-free positions you much better to (1) withstand economic tough times and (2) readily respond to God's leading.
- One caveat. When paying off a mortgage early, it's generally best to do so with available cash flow. Don't raid a retirement account or wipe out your emergency fund to do this.
Doesn't the interest rate matter? Some argue that the decision to prepay a mortgage depends on the interest rate. If your mortgage rate is relatively low, they would tell you not to prepay your mortgage; invest the money instead.
However, investments come with no guarantees. In fact, you could lose money. But every dollar you devote to prepaying your mortgage is guaranteed to "earn" the equivalent of the mortgage's interest rate and advance you financially.
Doesn't the tax deduction matter? Fans of not prepaying a mortgage also tout the tax deduction you get from mortgage interest. However, paying $1 to save 25 or 30 cents on taxes doesn't make any sense. Also, interest makes up a declining portion of your payment as the mortgage ages anyway.
Without a mortgage, you may not be able to itemize, but you can take the standard deduction, currently a sizeable $12,400 for married couples filing jointly. (Property taxes and charitable giving will continue to qualify many households for itemized deductions.)
Bottom line? It is wise to pay off your mortgage by age 65 at the latest. If you're free of other debts, have a sufficient emergency fund, and are making adequate progress saving for retirement/college, it's beneficial to pay it off even earlier.
Matt Bell is Associate Editor at Sound Mind Investing. Since its founding by Austin Pryor in 1990, SMI has been providing clear, trustworthy, market-beating investment guidance to the Christian community. Some 10,000 subscribers look to its flagship publication, the Sound Mind Investing monthly newsletter, for biblical guidance on a range of financial issues and specific investment advice. Matt is also the author of four personal finance books published by NavPress, and speaks at churches, universities, and other venues throughout the country.
Publication date: April 2, 2014