In most cases, paying off debts early is a smart financial idea, as you’ll save money on interest owed. But when it comes to a mortgage, this isn’t always the case — in some cases, you may be penalized and end up paying more if you pay this debt off before the full mortgage term. Plus, there are other reasons why it may not make financial sense for you to pay off a mortgage early.
Here are the circumstances in which it may not pay to pay off your mortgage early.
A Focus on Mortgage Payments May Mean Missing Out on Other Investments
“A con of paying off your mortgage early is that the payments are higher and may crowd out other investments — for instance, contributing to a retirement plan or funding a child’s college fund,” said Robert R. Johnson, Ph.D., CFA, professor of finance at Heider College of Business, Creighton University. “Some borrowers mistakenly view the purchase of a home as their chief investment. If mortgage payments are so large as a percentage of monthly income that people can’t adequately fund their retirement account or a child’s college education account, then it may be wise to simply pay your mortgage over the normal term of the loan.”
Investing in the stock market may also be a better use of your funds than paying your mortgage off early.
“Noble laureate economist and Yale professor Robert Shiller makes a compelling case that real estate, particularly residential homes, is a much inferior investment when compared to stocks,” Johnson said. “Shiller finds that on an inflation-adjusted basis, the average home price has increased only 0.6% annually over the past 100 years. Contrast that with the stock market. According to data compiled by Ibbotson Associates, the average return on the S&P 500 has been approximately 10% while inflation has averaged around 3%. The inflation-adjusted return of the stock market over the past 90 years has been approximately 7%.”
You Have Debt With Higher Interest Rates
“Although a mortgage is often the largest debt in the household, it usually has one of the lowest [interest] rates and a rate below what can be earned on that money,” said Doug Perry, strategic financing advisor at Real Estate Bees.
Instead, you’d be better off paying off your highest interest rate debt first, which is often unsecured debt such as credit card debt and personal loans, Perry said.
You Don’t Have an Emergency Fund
Paying off your mortgage early may give you peace of mind, but it should never be prioritized over building up an emergency fund.
“Once you pay off debt or pay down debt, you now have more equity but less in available cash when needed,” said Dr. David Phelps, real estate investor and founder and CEO of Freedom Founders. “There is safety in cash and cash flow. Equity also provides a level of safety, but cash flow is the oxygen that maintains your business or personal revenue needs. Equity by itself cannot do that.”
Your Mortgage Has an Early Payoff Penalty
“While early payoff penalties for mortgages are not very common, they do exist,” said Tolen Teigen, CFA, CFP, chief investment officer for FinDec. “You would have to look at what the penalty is and the interest rate on the penalty, and weigh the interest rate you’d be paying with the penalty versus anything else you have debt-wise.”
More From GOBankingRates
Last updated: Oct. 13, 2021
This article originally appeared on GOBankingRates.com: Why It’s Not Always Smart To Pay Off Your Mortgage Early