Should I pay off my mortgage early?

Getting rid of your mortgage may sound great, making you want to pay down your debt as soon as possible. However, the amount you save when you pay off your mortgage early might not be more than what you would earn if you put those funds to work elsewhere. On the other hand, the benefits of paying off your mortgage early, such as gaining peace of mind, could make paying your mortgage early worthwhile.

Can you pay off your mortgage early?

The short answer is yes — you can pay off your mortgage early. This is called prepaying a mortgage. But there may be consequences to paying it off early.

Before paying off a loan ahead of schedule, it’s important to read the fine print. Based on the terms of your loan, you could be subject to a prepayment penalty for paying off your mortgage early. Typically, loans older than three years are not subject to this type of penalty. If your mortgage is less than three years old, you might have to pay a prepayment penalty to pay it off in full, depending on what your loan contract states.

Pros and cons of paying off your mortgage early

It’s important to weigh the benefits of paying off your mortgage early, as well as the cons, which include:

Pros

• Eliminates your monthly mortgage payment, freeing up extra funds
• Potentially saves you thousands of dollars in interest
• Offers a predictable rate of return, equivalent to the interest rate on the balance you’re paying off
• Provides peace of mind knowing you own your home outright
• Allows you to tap the equity in your home if you need money in the future

Cons

• Ties up a good chunk of your liquidity and net worth in your home, which might make it harder to access later
• No longer eligible for the federal mortgage interest tax deduction if you are still claiming it
• Could miss out on potential higher returns from other investments
• Might not realize as much from your home as you had hoped if the market drops and you have to sell quickly

Things to consider for early mortgage payoff

1. Will other investments beat paying off a mortgage early?

Should you pay off your mortgage or invest? Ultimately, it’s a personal decision, but investing could be more sensible. “Sadly, the math tells us it’s almost always better to invest in other places than in your mortgage,” says Richard Bowen, CPA and owner of Bowen Accounting in Bakersfield, California.

Mortgage rates have risen significantly in 2022 and 2023 but are still somewhat lower than the average long-term return of the stock market. On average, the S&P 500 has returned 10 percent over the last 90 years. That means that it’s theoretically a better call to invest than to pay off mortgage debt. This can be especially true if you carefully invest your extra money in a tax-advantaged account like a 401(k), traditional IRA, health savings account, or 529 college savings plan.

However, that S&P average ignores volatility in returns. While you might see a 10 percent appreciation over the long term, you could see a year, five years or even more with much lower returns. There’s also a lot to be said about the psychological benefits of paying off debt, not to mention freeing up space in your monthly budget.

Any choice poses a risk, however. Even after paying off your mortgage early, real estate prices could plunge, leaving you with a potential loss. “The thing is, no one can give you a guarantee on an investment,” says Bowen. “You can put your money in the stock market and lose it. You can put your money in real estate and it doesn’t perform as well as you expected it to.”

2. Will all your cash be tied up in the mortgage?

Before taking a large chunk of your wealth and using it to pay off your mortgage early, don’t forget to look at liquidity. Your home is considered a non-liquid asset because it can take months — or longer — to sell the property and access the capital.

“If you start paying down your mortgage too fast, you risk depleting your liquidity,” says Amanda Thomas, CFP, a partner and director at Mission Wealth in Santa Barbara, California. “The kind of liquidity you have is important, too.”

One approach is to have an emergency fund, as well as assets like stocks, mutual funds, U.S. Treasuries, bonds and marketable securities available in a taxable investment account. That way, in addition to having money tied up in tax-advantaged retirement accounts and your home, you still have some cash or other investments that are easy to convert to cash in a pinch.

Bowen suggests maintaining a cushion that protects you for at least six months before you consider using a large portion of your liquid assets to pay off your mortgage early.

3. How will you use the money if you don’t pay off your mortgage early?

Be realistic about what you’ll likely do with your money if you don’t use it to retire your mortgage debt. After the mortgage is paid off, will you actually use it to get ahead?

It might make sense, for example, to put the money into paying off your mortgage early if you struggle with keeping money in the bank. Your home can be a forced-savings tool, and making extra mortgage payments can save you thousands of dollars in interest over time, plus help you build equity in your home faster.

“The right thing to do is the thing you will do,” says Bowen. “All of this has to do with personal habits. If you’re going to blow through the extra money anyway, then it’s better that you put it into your house than spend it.”

4. How much do you value peace of mind?

Sometimes, it’s less about the bottom line and more about peace of mind. If you own your home free and clear, that can provide benefits that can’t be measured in strictly financial terms. For many, eliminating a monthly mortgage payment ahead of retirement can provide mental relief when considering living on a fixed income.

“Personally, I’m paying down my mortgage,” says Thomas. “It feels good to have it paid off before retirement. It might not always make financial sense, but it offers peace of mind and it might allow for better budgeting.”

Another potential advantage is the ability to borrow against the equity in your home. Having a considerable amount of equity can allow you to establish a home equity line of credit (HELOC), providing a source of emergency income, as well as allowing you to make home improvements or make progress toward other financial goals.

Is early mortgage payoff right for you?

Paying off a mortgage early is often a consideration for homeowners looking to retire early or stay in their homes for an extended time.

Ultimately, the decision comes down to personal preference and whether the benefits outweigh the costs. Consider any prepayment penalty and the potential tax consequences. Also, conduct an inventory of your finances to determine if it’s more sensible to use the funds elsewhere, like to eliminate high-interest debt.

If you do decide not to pay off your mortgage early, make sure to be productive with those extra funds. You want to put that money to good use and earn better returns than you’d have received by paying off your debt. For example, use that money to:

• Invest in the stock market to increase your earning potential.
• Increase your retirement savings by making higher contributions.
• Fund your child’s education by contributing to an education savings plan.
• Build (or add to) an emergency fund.
• Pay off high-interest credit cards, personal loans or student loan debt to save a bundle in interest.

Also, take the time to check mortgage rates and see if refinancing could help you save money, especially if you plan to stay in your home for a long time.

Frequently asked questions on paying off your mortgage early

• How much will a prepayment penalty cost me?

  Generally, mortgage lenders are prohibited from imposing prepayment penalties on most home loans under the Dodd-Frank Act. While changes to Dodd-Frank have occurred in recent years, prepayment penalties are still subject to regulations.
  
  
  If your mortgage is the exception to the rule, a prepayment penalty can only be assessed in the first three years. It’s capped at 2 percent in years one and two and 1 percent in year three. So, if your outstanding loan balance in year two is $295,000 and you pay your mortgage off, the lender could charge a prepayment penalty of up to $5,900.
  

• How do you prepay your mortgage?

  If you have the money, there are multiple ways you can prepay your mortgage. You can spread out extra payments over time or pay one lump sum payment. When you make any extra payments, be sure to specify that the money should go toward paying down the principal of your loan or the lender may apply it to your next payment.