I think it’s safe to say that no one looks forward to a 30-year obligation to a bank. While mortgages open up the opportunity for many of us to acquire properties (whether they’re for us or real estate investing), it’s not a great feeling to think about how old you’ll be when your mortgage is paid in full. But what if you come into some extra money and want to pay off your mortgage now? Is there a disadvantage to paying off a mortgage early?
Paying off your mortgage early comes down to personal preference. Putting extra money to pay off a mortgage early means more peace of mind but less opportunity for investing that money elsewhere. If you can find something that pays you a higher interest rate than the interest rate on your mortgage, it might be worth diverting those funds into investments instead.
I know it’s not a great answer. Unfortunately, there’s no straight “yes” or “no” to this question as it’s a personal decision that depends on your risk tolerance levels. So let’s discuss why someone might want to pay off their mortgage early or other ways to use those funds to their advantage. Plus, I’ll let you in on my favorite way to double-dip and get the best of both worlds.
Why Would Someone Pay Off Their Mortgage Ahead of Schedule?
The decision to pay off a mortgage early comes down to personal preference. Let’s look at it from the perspective of someone who wants as little risk as possible.
Paying off your mortgage early means that you’re under no further obligation to your lender. You’ll still be on the hook for insurance and taxes, sure, but that monthly mortgage payment will be off of your shoulders. With your home loan now paid in full, you then start accruing equity on your home. The more the value increases on your house, the more your net worth grows.
There is something to be said for the peace of mind that comes with knowing your home is owned outright by you. In some ways, it makes a lot of sense, right?
But here’s the flip side: While you’ve shaved off a decade’s worth of payments later, you haven’t accrued any additional money now. That extra money could’ve put you in a much better position in terms of safety nets, investment opportunities, and even additional income. Let’s talk about that perspective next.
Is There a Disadvantage to Paying Off a Mortgage Early?
A home mortgage usually has a timespan of a few decades. Consequently, since they’re so long, they often have a low interest rate compared to other types of loans. This is especially prevalent in 2021, with interest rates being at an all-time low.
More often than not, you’ll hear that it’s a bad idea to pay your mortgage off early due to the loss of tax deductions and the consideration of your opportunity cost. If you’re unfamiliar with the term, “opportunity cost” is like a cost-benefit situation.
Think of it like this: Say your mortgage is for $300,000 and is structured for 30 years at 2.5% interest. We’ll pretend that your monthly mortgage payment is a nice, round number of $500 every month. You’d like to pay $1500 every month instead to shave years off the back-end of your mortgage.
The opportunity cost comes into play here. Is it more beneficial for you to put that extra $1000 a month towards paying off your mortgage at 2.5% interest, or could you put it into something else which pays you more than 2.5%, like mutual funds or private lending?
So if you paid off that $300,000 mortgage, you’d save yourself that 2.5% interest. But if you didn’t pay off the mortgage and instead put those payments into something else which earned 5% – 8% interest, you’d actually make more money.
This is what’s known as a leverage situation. That $1,000 diverted into investments instead of a mortgage could earn you back your $1,000 and more. It’d be like double-dipping: you’d still get to put that $1,000 back into your mortgage and would reap the benefits of a higher interest rate being paid to you.
A Note About Risk
However, I want to mention that there is no guarantee to this. I am not a financial advisor and cannot give you investment advice for your unique situation. Understand that there’s always the possibility that an investment could go south, losing your investment altogether. Plus, you’d still be on the hook for your mortgage.
If that freaks you out a little too much, there’s also the option of tossing an extra $50 or so every month towards your mortgage and then using the “extra” to invest as you see fit. This is an excellent strategy for someone interested in taking on some risk but still wants to shave time off of their mortgage obligation.
My Favorite Way to Handle Paying Off a Mortgage Early
There’s a sweet spot in the middle of all of this that gets you the best of both worlds. Consider the option of paying off your mortgage early and then using that equity to get a line of credit (LOC).
Lines of credit are often secured against collateral like the equity a homeowner has in their property. Unlike loans, lines of credit revolve and don’t accrue interest until you draw on them. So if you have a line of credit worth $200,000 and want to withdraw $50,000 to use for investing, you wouldn’t need to make payments on the entire $200,000 value.
Now, you’ll need to have decent credit to be approved for a LOC. But once approved, that money is yours to do with what you like. What I prefer to do is use that line of credit for short-term home investing. I’ll use it for things like down payments, repair costs, or even hard money lending.
In addition, if something should go wrong with my own home, I can do what’s known as an “equity swap” and just move into the investment property. Granted, this is an extreme situation, but it is still available nonetheless.
So is there a direct disadvantage to paying off a mortgage early? The straight answer is “no,” but the actual answer is “it depends.” Your comfort level when it comes to risk is a critical factor that can sway the answer to either side. If you’d prefer the peace of mind that comes with owning your home outright, then no, there’s no disadvantage.
However, if you’re comfortable with risk and want to increase your opportunity to make more money, then yes, there are some disadvantages to putting extra money into a mortgage.
What are your thoughts on the opportunity cost of paying a mortgage off early? Leave a comment and let us know!