Interest rates are so low these days that you may think it’s impossible to find a no-risk investment that pays 5 percent or more. Yet that’s what you’ll earn if you make extra payments against your mortgage. Paying off your mortgage early saves a lot of interest because the total amount of money you fork over to your lender will be less — sometimes far less — than it would be if you took the typical 30 years.
There’s an added advantage for anyone planning for retirement: If you pay off your mortgage by the time you retire, or shortly thereafter, you'll require less income to support yourself during retirement. Retirees who are still making mortgage payments or are renting need to come up with a big chunk of change every month.
Pros and cons of mortgage prepayment. The classic argument against making extra mortgage payments is that you can earn a higher return from the stock market than you can from the interest you save on your mortgage. That's not always the case. In the past decade, the Standard & Poor’s 500 Index, the benchmark for stock returns, has lost money.
Even if you believe that stocks will do better over time, if your investments are diversified, some of your money is held in interest-earning investments. Money-market funds, CDs and savings accounts are paying miniscule interest. In a low interest-rate environment, it can make more sense to use that money to reduce your mortgage balance instead.
Other opponents of prepaying a mortgage argue that you’ll be giving up a lot of the tax savings on the mortgage interest. True, every extra payment reduces the deductible interest on the loan. But even though your tax deductions shrink when you accelerate mortgage payments, you're usually still ahead financially because for every dollar of mortgage interest you pay out, you save only a fraction of that dollar in taxes.
Besides, the portion of your monthly payment that goes to interest gradually subsides over the life of the loan. Toward the end of your mortgage, virtually all of your payment goes to the principal, which isn't tax deductible.
Some priorities trump prepayment. There are legitimate reasons why you should delay making extra mortgage payments. Before you write a big check to your home lender, be sure these financial priorities are addressed:
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