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Why You Should Pay Off Your Mortgage Early and How to Do It

Updated on May 6, 2012

Should You Pay Off Your Mortgage Early?

Are you wondering if you should pay off your mortgage early? This is a common financial question and one that deserves careful consideration. There are those in the camp of keeping a mortgage payment for the tax write-off and low borrowing costs. They say, "Why pay off the mortgage if you can invest that money and earn a higher return?" However, the new reality of investing has changed this logic. Today, with interest rates on a 30 year Treasury Bond hovering at about 3%, a roller-coaster stock market, and mortgage interest at about 4%, the benefit of paying off your mortgage early is becoming more clear. In addition, those who pay off their mortgage early pay much less in interest over the life of their loan, will have peace of mind that they'll always have a low cost place to live, and may be able to retire earlier as well.

CC BY:  Via Flickr
CC BY: Via Flickr | Source

Why You Should Pay Off Your Mortgage Early

You should pay off your mortgage early for all of the reasons already mentioned.

First of all, paying off your mortgage early is a good investment. If you have extra money sitting in a savings account right now, chances are that it's earning less than 1% interest. If you take that money and use some of it to pay down your mortgage, you will very likely earn a higher rate of return.

You first need to figure out your after tax mortgage rate and then compare that to the investment returns you could expect if you invested the money instead. In order to determine your after tax mortgage rate, simply multiply your current mortgage interest rate by 1 minus your marginal tax rate. So, for example, if your mortgage is 5% and your tax rate is 25%, your after tax mortgage rate is 5 x (1-.25) = 4.25%. If you can't earn more than 4.25% on your investments, which is difficult in today's environment, then it's probably a wise thing to pay down your mortgage early.

Second, paying off your mortgage early will give you peace of mind. Imagine having no monthly payment for your housing. Wouldn't it give you a great sense of security to know that you can live there without paying rent? Of course, you'd still have property taxes, insurance, and maintenance, but the cost of these pales in comparison to the mortgage and interest you've been paying.

Third, paying off your mortgage early will allow you to pay far less interest on your loan overall. Using the amortization schedule in the attached link above, you'll be able to play around with extra payments to see the impact on the pay-off date and the total amount of interest you'll pay. For example, if you have a $200,000 30-year mortgage at 5% interest, you'll pay a total of $186,511 in interest payments over those 30 years. However, if you make extra payments of $200 per month, you'll pay only $92,059 in interest, a savings of $94,452, and you'll pay off the mortgage nearly 9 years early! The more you accelerate your mortgage payments the less you'll pay in interest.

Finally, paying off your mortgage early will allow you to retire earlier. If you don't have a mortgage payment, you'll need less income in retirement to pay your expenses. If you need less income in retirement, you'll require a smaller nest egg to produce that income. If you require a smaller nest egg, you can retire earlier because you'll reach your savings goal that much earlier. In addition, paying off your mortgage early will allow you to funnel the money into retirement savings instead.

Pay Off Other Debt Before Paying Off Your Mortgage

Before you even think about paying off your mortgage early, you should pay off all other debt. If you have a loan on your car, pay that off first or sell the car and buy a less expensive one for cash. If you have credit card debt, that should also be paid off before paying off your mortgage. Finally, if you have student loans, these should also be paid off before paying off your mortgage early. There should be no exceptions to this rule.

How to Pay Off Your Mortgage Early

Now that you've decided to pay off your mortgage early, there are many ways to actually achieve your goal. Here are a few tried and true methods to paying off your mortgage much faster:

  • Refinance to a shorter loan term: A big trend right now is to refinance to a 15 year loan and there are very compelling reasons to do so. First, the interest rates are lower than for a 30 year fixed rate loan. At the time of this writing, a 15 year fixed loan was averaging 3% while a 30 year fixed loan was averaing 3.8%. While this may not seem like a huge difference, it can add up quickly. Play around with the amortization calculator to see what I mean. Second, with a 15 year loan, you'll pay off your mortgage in half the time, which is, after all, the goal. One draw-back of the 15 year mortgage is that your payments will be higher and you'll be locked in to these higher payments. In contrast, with a 30 year loan, the payments are lower and you can pay extra on the loan when you can afford it.
  • Pay a fixed amount extra every month: You may want to get a 30 year loan for the lower payment commitment and then pay a fixed amount extra every month. You can use the amortization calculator to see the impact of extra payments of differing amounts. This is a great way to shave time and interest off of your mortgage without being locked into higher payments of a 15 year mortgage.
  • Make an extra payment every year: If you can't afford to make a fixed extra payment every month, try making an extra payment every year. This can also have a dramatic affect on your mortgage balance and the interest you pay over the life of the loan.
  • Round your payment up each month: This is probably the easiest and least disruptive way to pay down your mortgage faster, although it also has the least impact. For those who just don't feel like they can come up with enough money for the options above, why not just round up your payments? If your mortgage payment is $950 per month, pay $1000 instead. You probably won't miss that extra $50 and it will make a dent on the mortgage and interest.
  • Go with a bi-weekly mortgage: This is my least favorite option because it requires sending two mortgage payments per month and it's just another way to make an extra payment every year. With a bi-weekly mortgage you'll end up making an extra payment, thereby reducing your mortgage faster. However, for me, the hassle of making two payments a month outweighs the benefit of actually signing up for one of these. I'd much rather just make the extra payments myself. But if you need the forced discipline then this might work well for you.

Paying Off Your Mortgage Early

Paying off your mortgage early is a goal worthy of achieving. You'll save money on interest payments, have peace of mind, and be able to retire earlier. It can be achieved relatively easily if you make the effort to make extra payments or if you obtain a 15 year mortgage. Perhaps the key to all of this is to purchase an affordable home in the first place. Live well within your means, buy a smaller house than you may actually want, and pay it off early. The benefits will be worth it.

What are your plans for paying off your mortgage?

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    • Millionaire Tips profile image

      Shasta Matova 5 years ago from USA

      This is great advice - you have so clearly showcased the importance of paying your mortgage off early. My mortgage is paid off and the peace of mind is incredible!

    • SD Dickens profile image

      SD Dickens 5 years ago

      Thanks Bankscottage for the positive comments and for the information about loan modification. I'm going to ask my lender for the same!

    • bankscottage profile image

      bankscottage 5 years ago from Pennsylvania

      Bullseye! You are spot on with this Hub. It is excellent.

      I no longer buy that mortgage interest is ok because you can deduct it. The interest still seems a waste of money to me. You hit all of the reasons I am paying off my mortgage early.

      One other way to pay off your mortgage early is to ask your lender for a loan modification. It will change the interest rate and the payment, but not the term (with refinancing, you start all over again at 15 or 30 years). You cannot take cash out with a modification like you can with a refinance but that would defeat the purpose here. My mortgage is with a credit union that keeps all of their loans in house. I was able to request a mortgage modification and reduce my interest rate to 3.625% just by asking. No fees. No reapplication. And the term of the loan did not change. Despite my payment going down, since I was comfortable with the original payment, I am continuing to pay that amount and will pay off my loan even sooner.

      Another advantage of a smaller house, lower maintenance and often lower taxes. Also, you can't put as much "stuff" in them so you'll save money by never buying the "stuff" in the first place. Not every lender can or well do this, but it never hurts to ask.

      There is one slight correction, the after tax mortgage rate for a 5% loan, 25% bracket is 3.75%. But, even that investment rate isn't necessarily easy to achieve today.

      Voted Up, Useful, and Shared.

    • jasmith1 profile image

      Adrian Smith 5 years ago from UK

      This is great. We are currently working to pay off our mortgage early for the reasons you list above. I didn't realise how much extra you pay in interest (as you stated, now approx the property price again over a normal term) - when we realised we made it our goal to pay off more each month and are seeing the benefits already as well as the satisfaction of knowing that we are working towards a worthwhile goal. Thanks for a very well written and educational hub.