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Not So Fast: Think Before Paying Off Mortgage Early

Many homeowners dream of the day when they'll mail in their final mortgage payment and own their homes "free and clear." In anticipation of that day, some homeowners speed up their mortgage payments by paying more toward the principal whenever they have some extra cash. By accelerating payments, not only will they pay off their mortgage sooner, but they'll also cut down on the total interest they'll pay over the life of the mortgage.

Although these prepaying homeowners think they're doing themselves a great service, some financial advisers say they're making a mistake. Their argument: When you prepay your mortgage, you're basically investing in your house. As an investment, it's extremely non-liquid and the transaction costs to sell it are phenomenally high.

Plus, when you put all of your extra money into your house, you have nothing left over to fund other investments. This goes against the basics of smart financial planning. For years, financial experts have stressed the importance of a diversified portfolio. However, when you put all your money into mortgage prepayment, the only return is the appreciation of your house. That can be the opposite of a diversified portfolio. Of course, it all depends on where you are investing and what is happening with the stock market if that is where you are putting the majority of your money.

Despite these facts, many homeowners still want the emotional high that comes with fully owning their own home. If you're one of them, you should consider the following factors before paying off a mortgage:

Factor#1: Your Mortgage Rate

If you have a 30-year mortgage with a low fixed rate, financial advisers usually say it's best to stretch out your payments for as long as possible. With this kind of mortgage, you shouldn't even consider prepaying unless all your debts are paid off and you have enough money to put in other investments as well. On the other hand, if you have a higher interest rate of 8 percent or more, you should generally either pay off your mortgage as quickly as possible or refinance.

Factor #2: Credit Card Debt

If you are carrying any credit card debt, the thought of prepaying your mortgage should not even cross your mind. Because credit card debt typically carries a high interest rate, you should generally focus on paying it off before anything else.

Factor #3: Investments

Financial advisers often say that when you spend your money prepaying your mortgage, you're basically leaving free money on the table. How so? Because if you spend all your extra funds on mortgage prepayment, that means you're not investing in your 401(k) at work or other tax-deferred retirement plans.

If you are fortunate enough to have an employer that "matches" the amount of money you put in a 401(k), it's considered a "no-brainer" investment. Some financial advisors go so far to say that consumers should put the minimum in their 401(k) to get their employer's match before even paying off their credit card debt. After all, it's a 100 percent return on your money.

So once you've gotten rid of your credit card debt, you're investing money in a diversified portfolio and you've built up a healthy savings account, then is it a good time to prepay your mortgage? More considerations:

  • If you have a fixed low-rate mortgage, your fixed monthly payment will become an even better deal as the years pass and inflation increases.
  • You'll probably benefit from deducting mortgage interest on your income taxes.
  • If you use the money to invest elsewhere, you'll have other valuable investments earning money for you. In the long run, paying off your mortgage isn't going to add to your wealth-and it can actually subtract from your potential wealth because you could be putting that money into more valuable investments. Prepaying your mortgage is obviously a personal and emotional decision. If you are considering paying off your mortgage, discuss your options with a professional.