Should You Pay Off Your Mortgage Early?

Most homeowners look forward to the day when they'll make that last mortgage payment. But there may be financial benefits related to your home mortgage that you'll lose out on when it's paid off. And paying your loan off early comes with an opportunity cost. That is, you'll have less money for emergencies or other spending options that may earn you a higher return than prepaying your mortgage. Before you speed up your mortgage payments, here are some pros and cons to consider.

Cash Flow

First and foremost, it's a good idea to set aside at least six months of living expenses for an unexpected hardship. So if you don't already have that much cash in reserve, consider hitting that mark before you make any extra mortgage payments.

Stockpiling cash makes sense in part because the money is readily accessible. Conversely, after you make mortgage payments, it can be difficult to access the money. You may be able to get a home equity loan or line of credit, but it's harder to do now than it was a few years ago.

You also might be glad you don't have so much wealth tied up in your home if property values decline. Consider the dilemma of people who bought homes in high-priced markets around 2005, only to see the value of their residences collapse. Many of these homeowners wound up "upside-down" on their mortgages — that is, they owed more than their homes were worth.

Return on Investment

If you have money to spare after setting aside a cash reserve, consider your likely return on investment from extra mortgage payments vs. doing something else with that money. For example, when you pay down a 5% mortgage you might think your return is 5%. Don't forget, though, that if you itemize, you can generally deduct mortgage interest in calculating your taxable income. This benefit effectively lowers the true cost of your mortgage.

If you think you have a reasonable chance to get a better return by doing something else with the extra money, it may make sense to try. For instance, if you carry a credit card balance or other higher-interest debt, your best alternative likely will be to pay it down. After all, reducing a debt costing you 22% (or even 14%) annually provides a significantly greater return than making extra payments on a 5% mortgage. Plus, unlike mortgage interest, nonbusiness credit-card interest isn't deductible.

Another smart alternative is to make additional contributions to your 401(k) or IRA. This not only can reduce your taxable income and position you to reap the benefits of tax-deferred compounding, but also may increase employer matching contributions if available.

If you don't carry other debt and you've already maxed out your retirement plan contributions, consider other investment options. If, for example, you work for a public company and are allowed to purchase shares of that stock at a discount, doing so might provide a better return than paying down your mortgage early. Just be aware that large holdings in one stock can be risky.

Ask the Experts

Given the many factors involved, you may want to keep the mortgage-burning party on hold for the moment. Then again, if you have the liquidity and you'll sleep better without a large debt hanging over your head, you might prefer to pay off your mortgage as quickly as possible. Ask your financial advisor for help making this important decision.