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You open your monthly mortgage statement one morning and nearly spit out your coffee — your loan balance reads zero. It’s a familiar daydream that also feels like a distant fantasy to many homeowners who have a home loan.
If you discover extra funds in your budget, you could experience the sensation of a mortgage-free life sooner than you planned.
Whether you recently landed a pay bump or inherited a tidy sum, putting additional cash toward your principal mortgage balance can help you pay off your mortgage early. But is paying off your mortgage loan the best financial strategy? Some financial experts argue that mortgage debt could be considered “good debt.”
Should I pay off my mortgage?
In certain situations, it could be better to hold on to your mortgage and make regular payments as scheduled. In other instances, paying down your loan and eliminating your mortgage early could give you a boost to explore other financial options.
Figuring out the best way to channel your extra cash boils down to your personal situation. The decision hinges on both your financial profile and your philosophy about whether the extra money could be put to better use elsewhere.
To walk us through the ins and outs of mortgage payments, we spoke with two industry leaders who know a thing or two about mortgages:
- Chloé Moore, an Atlanta-based certified financial planner (CFP®) ranked as one of the 100 top financial advisors in 2021 by Investopedia
- Arkansas real estate agent Tara Limbird, whose team landed on the Wall Street Journal’s list of top real estate firms in the U.S
Here’s what you need to know before diverting extra funds to your home loan and paying it off early.
The basics: how paying off your mortgage early works
Every time you make your monthly mortgage payment, your loan servicer applies a portion of the payment toward paying down your loan balance, while the remainder pays for interest.
Although you pay a fixed amount each month, the split changes with every payment. At the beginning of your loan term, a larger portion of your payment pays for interest. But as you pay down the loan balance, your interest fees decrease. Over time, the split reverses — and a larger chunk of the monthly payment applies to your loan balance than to interest fees.
Let’s say you take out a $240,000 mortgage loan to purchase a $300,000 home. You lock in a 3% fixed interest rate over 30 years, and your monthly payment totals $1,012. When you make your first payment, $412 of your payment applies to the loan balance while $600 pays for interest. And after making faithful payments for 15 years, the loan balance drops to just over $146,000. With a lower loan balance, you pay less in interest fees, or $368. The larger remainder, $644, pays down your principal.
See the table below for an example of how the interest fee and loan balances change over time with regular payments.
Example of how mortgage payments amortize over time
|Month||Loan balance||Principal paid||Interest paid|
After 30 years of monthly payments, you’d pay a cumulative total of $124,666 in interest and the loan balance in full.
Adding to your regular payment pays off your mortgage sooner
What happens if you pay an extra $100 every month toward the same loan’s principal balance? Two things: you pay less in overall interest, and you pay off your loan faster. That’s because the extra payments accelerate paying down the mortgage balance, which in turn reduces interest fees.
According to Freddie Mac’s Extra Mortgage Payments Calculator, you’d save $18,828 in total interest by the time you pay off the loan in our example. You’d also pay off the balance four years earlier than if you didn’t add an extra $100 to your monthly payment.
Pros of paying off your mortgage early
According to the U.S. Census, nearly 38% of homeowners don’t have a mortgage on their primary home. Here’s why it pays off to accelerate your home loan payments and join this enviable group:
Pay less interest over the life of the loan
By paying off your mortgage loan early, you’ll save on interest expenses over the life of the loan. Depending on your loan terms and the amount you prepay, your savings could add up to thousands of dollars, keeping more money in your pocket over the long term.
Free up cash for other purchases or investments
According to the U.S. Census Bureau’s 2019 American Community Survey, the median monthly housing cost for homeowners with a mortgage was $1,609. For homeowners without a mortgage? $505. That’s an extra $1,104 each month that could be diverted to investments for early retirement, or to fund a once-in-a-lifetime trip to Tahiti.
When you’re mortgage free, cash that was once budgeted for mortgage payments could be put toward other financial goals, says Moore.
Gain peace of mind
If you’re risk averse, paying off your mortgage early may take a weight off your mind, knowing that you own your home outright. “For some, the piece of mind that comes with being debt free far outweighs any financial benefits,” says Moore.
Limbird agrees, adding that while there may be reasons why it’s better not to pay off your mortgage early, “for some people … it’s almost a sense of accomplishment to have your home paid for.”
Transform your financial outlook and mindset
A staunch advocate for paying off all debt regardless of the type, financial guru Dave Ramsey recommends venturing into investment properties to accelerate wealth after paying off your home loan, not before. When you pay off your mortgage, “it changes the way you operate the rest of your money, because you’re standing on such a more solid foundation to live your life,” says Ramsey.
Cons of paying off your mortgage early
A mortgage-free life may offer a sense of accomplishment and freedom, but diverting excess cash to your home loan could limit you in other ways. These are some reasons why allocating your extra budget elsewhere may prove better use of your money.
You could lose out on a tax benefit for having a mortgage
If you itemize deductions on your federal tax return, you won’t be able to itemize the mortgage interest tax deduction after your home loan is paid off, since you’ll stop making interest payments. However, you’d still be able to deduct property tax expenses if you qualify.
For most homeowners, the lost deduction won’t affect their taxes. According to the IRS, only 11.4% of individual tax returns filed in 2019 included itemized deductions. The majority of individual tax filers opted for the standard deduction, which doesn’t allow for an itemized interest deduction.
It may be wiser to channel extra income to higher interest debt
If you carry credit card or personal loan debt along with a mortgage loan, it probably makes sense to divert extra funds toward that higher interest debt before paying off your mortgage. The U.S. News reports that the average annual percentage rate (APR) for credit cards in their database ranges from 15.56% to 22.87%.
When compared to sub-3% mortgage interest rates as of October 2021, it’s likely that you’ll save more on interest fees per dollar borrowed if you prioritize high-interest consumer debt first before your mortgage.
You might benefit more by investing the extra income
Limbird points out that with historically low mortgage interest rates, it’s “very cheap to borrow” money for a home. “It might be advantageous for someone to be putting that [extra] money into a retirement plan” instead, she points out. Limbird also encourages homeowners to speak with their financial advisor about potential investments. “If your interest rate is 2.5% or 3% … If you could earn more than that, then you’re gonna come out ahead.”
Moore agrees that there’s potential to earn more overall by investing extra cash instead of paying off a mortgage. In some cases, homeowners “can position themselves to pay off the mortgage balance from their investments down the road,” she suggests.
It tough to withdraw equity from your home if you need it fast
By making extra loan payments, you increase the amount of equity you have in your home. Home equity, considered an illiquid asset that can’t easily be withdrawn, isn’t easy to tap into if you’re in need of funds fast.
If you’re saddled with an unexpected expense or have an emergency, it takes time to access funds tied up in your home. You’ll either need to sell your home or refinance to access cash from your home equity. If you don’t have an emergency fund that’s easy to access, you may want to reconsider paying down your mortgage balance first.
You may need the extra funds for more pressing priorities
Other financial goals could take precedence over paying off your mortgage. You may want to establish a college account or retirement fund before you channel extra funds to your mortgage. Or perhaps you’re ready to retire an old vehicle. It may make sense to attend to other financial obligations before your home loan balance.
Your loan servicer might charge a prepayment penalty
Some lenders charge a penalty fee if you pay off your loan early, or if you pay a specific amount above what you owe for the month. Prepayment penalties don’t apply to all loans, and lenders must disclose whether a penalty applies to your loan before you sign the loan documents. Under the Truth in Lending Act (TILA), prepayment penalty terms must appear on an applicant’s loan disclosures.
Penalty amounts vary depending on the specific loan terms. Some lenders charge a percentage of the loan amount or interest fees for a set number of months. Other lenders charge a flat penalty fee or apply a sliding fee schedule, where a prepayment early in the loan term triggers one fee, while a prepayment five years later triggers a different penalty amount.
If you decide to pay off your mortgage early, commit to a strategic plan
You’re committed to paying off your mortgage early, but how should you do it? That all depends on your financial standing and comfort level. “I don’t feel that one method of paying off your mortgage early trumps the rest,” says Moore. “The best decision for you is based on your current mortgage terms, financial situation, risk tolerance, and personal goals.”
To determine a strategy for paying off your mortgage, select a method that suits your financial profile. If you receive a pay raise, for example, you may want to commit that extra $200 every month to your loan payment. But if you receive a one-time inheritance, you might consider a single, lump sum payment to reduce your principal loan balance.
Pro tip: If you pay down your balance by submitting loan payments higher than your monthly minimum, Limbird says to make sure the loan servicing company applies the excess payment toward your balance, not as a prepayment for future months. Call your lender before you make the payment and confirm the company applies the correct amount to your balance when you receive your loan statement.
Methods for paying off your loan early
Compare the following payoff strategies by calculating how each method impacts your interest savings and payoff timeline. Use an online calculator such as Freddie Mac’s Extra Mortgage Payments Calculator to run the numbers. Then select the solution that works best for you.
Bi-weekly payments, or one extra monthly payment each year
When you set up a bi-weekly payment schedule with your loan servicer, you pay half of your monthly payment amount every other week. At the end of the year, you end up making 26 total payments, which adds up to 13 monthly payments instead of the usual 12.
Some mortgage servicers charge a fee for this service, but the Consumer Financial Protection Bureau (CFPB) says you can also make monthly payments as usual and add a 13th payment on your own. You’ll achieve the same result.
Add to your monthly payment
You can also choose a specific dollar amount that you’re comfortable budgeting and commit to adding that figure to your monthly mortgage payment. So if you owe $1,000 per month, you may feel comfortable allocating an extra $100 for a total of $1,100 each month.
Since you aren’t obligated to make the extra $100 each month, you can always skip the add-on amount if you find yourself in a temporary financial pickle. On the flip side, you could also choose to increase the add-on amount if you find extra room in your budget.
Refinance to a shorter loan term
Another strategy is to pay off your mortgage early by refinancing to a shorter loan term. With the refinance strategy, you apply for a new loan that pays off your existing mortgage. If your current loan term has 24 years remaining, for example, you could pay off your mortgage sooner by applying for a 10-year mortgage.
To determine whether refinancing fits your financial goals, calculate your interest savings and weigh the risk of taking on a higher monthly payment. And don’t forget — you typically incur closing costs when you refinance.
Moore points out that refinancing to a shorter loan term often requires a higher monthly payment amount — which you’re locked into for the duration of the loan. You’ll want to compare interest fee savings before you commit, she advises. “If your [current] interest rate is competitive and there are no prepayment penalties, it’s worthwhile to compare how much interest you’ll save with a refinance versus making additional payments,” says Moore.
Limbird also warns homeowners to consider carefully before choosing a shorter term and higher payment, particularly if your income fluctuates. If you rely on commissions or self-employment income, there’s a chance you could struggle with a higher payment during an economic downturn.
Lump sum payment
If you’d rather pay down your mortgage balance with a large chunk of extra cash, you could opt for a one-time additional payment. Your monthly payment remains the same, but a lower loan balance also reduces interest fees, which accelerates the balance payoff over time.
Weigh your options before paying off your mortgage early
Where you allocate extra funds can be a balancing act that requires strategic and individualized financial planning. Paying off a mortgage early can work well for one person’s finances but have a negative impact on another. If you’re in doubt, consult with a reputable financial advisor for advice that fits your specific situation. Ultimately, whether it’s a good idea to pay off your mortgage early or not depends on you.
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