Often when I meet with sellers who are considering a future move, one of the issues that comes up is their current mortgage balance aka what they own on their home. A seller’s focus is always what they will walk away with when their home is sold – their net proceeds.
Many older clients were raised with the idea that they should pay their mortgage off as soon as possible. I’m finding that my younger clients have the opposite idea – they’re just fine with never paying off their home!
So, what’s the right answer? Not surprisingly, it is “that depends.”
Before you make plans to approach “mortgage zero” let’s look at a few other ways of spending (or growing!) your money.
First, some context.
Because the local housing market has been extremely robust the last several years, your home may have significantly grown in value through market appreciation. But that’s a theoretical impact to your future bottom line; you won’t see the benefit of the housing boom until you decide to sell.
And if you bought recently, you likely had to pay top dollar for your home. So rather than feeling wealthy you may be feeling a bit pinched. And that feeling may lead to a desire to pay your mortgage balance early.
For some homeowners, that can be the right solution. I recently met with a client who confided their plans to pay off their mortgage in five to seven years. Not only will this save them an incredible amount of interest, they crave the feeling of financial empowerment that will result. At the end of the day, they didn’t want to owe money (and especially a very large chunk of money) to anyone.
They’re not alone. A 2018 survey showed that about half of those who responded wanted to pay their mortgage off early. Homeowners between the ages of 40 and 49 were most interested in this strategy.
If paying down your mortgage allows you more financial freedom, shouldn’t everyone do it?
Not necessarily! If there are other gaps in your financial picture, you may want to shore them up prior to prepaying your mortgage.
Build up rainy day savings. Do you have enough on hand to cover your mortgage, as well as all your daily living expenses, for six to twelve months? If not, you may want to get this account built up. A six-month cushion is the minimum to have on hand. As we’ve learned in the past year, there’s lots of unpredictability in life. With the average period of unemployment at 28+ weeks, it’s important to have that cushion in place to protect yourself.
Increase retirement contributions. If you have the stomach for some risk, you may want to maximize your contributions to 401K or IRA instruments. Over the long haul, funds invested in the market will offer a better return than paying down a mortgage with rates in the 2-4% range. Over the last 30 years, the S&P 500 has returned an average of 8% per year. And from 2011 to 2020, that rate jumped to 13.9%.
We all have different retirement savings goals. A calculator like the ones here or here will help you determine if you need to contribute more to reach your goals.
If you’re at your maximum contribution, or if you’ve met your goals, you’re closer to being in a position to pay down your mortgage early.
Contribute to a college savings plan. If you’re a parent or grandparent who wants to help your child with the burden of college expenses, you may want to invest in a 529 plan. Like the stock market, the idea is that the money compounding in that account will yield a larger return over time. This is especially true if you start the 529 plan while your children are young.
(Ron Lieber’s “The Price You Pay For College” is an excellent resource for those trying to navigate future college costs.)
Make sure your home is in great condition. If there are large capital projects needed at your home (think roofs, foundations, etc.) making sure these are addressed in a timely manner is important. Many home repairs, if not tackled up front, lead to much, much more expensive repairs down the road.
Refinance your current mortgage. While there can be costs to refinancing and it resets the clock for paying off your mortgage, it may seem counterproductive toward “saving” money by paying off a mortgage. But let’s think about this as a legitimate option.
With a good credit rating, you may qualify for what remains as some of the lowest interest rates we’ve ever seen. For example, if you qualify for a 3% mortgage and you’re currently in a 4.5% mortgage, and you plan to continue to live in your home, refinancing could make sense.
In this scenario you would simply take the monthly savings you realize as part of the refinance and apply it as additional principal payments to help reduce your mortgage balance more quickly. The beauty of this options is the financial flexibility it offers – if you run into financial hardship, you have a smaller nut to crack each month with a smaller mortgage, and you can suspend those extra principal payments until life smooths out.
The bottom line on your bottom line?
Paying your mortgage early may be a great solution for you. Typically, it depends on age. If you’re younger, be sure to pay attention to my notes above: especially your Rainy Day Savings. And be certain you aren’t existing on short term credit which comes at a high cost. If you find yourself with extra money from a bonus or inheritance, etc. be sure to pay off any high interest rate loans. I have more thoughts on the topic especially for the younger-than-me generation! Regardless, do your research, and make sure that you are getting the most financial bang for your buck.