Should You Pay Down Your Home Mortgage Early?
If you routinely have extra cash on hand after paying off your monthly bills, you might want to consider paying down your home mortgage balance faster than is required under your loan agreement. This can be a powerful way to invest surplus cash. But it’s not right for everyone.
Here are some hypothetical scenarios to show how effective this savings strategy can be, along with a potential downside to consider.
Super Savers Sally and Sam
Sally and her spouse Sam have positive monthly cash flow and extra cash on hand. They expect to be in the same financial position for the foreseeable future. The couple recently refinanced their 30-year mortgage. The current balance is $400,000, and the annual interest rate is 4%. Their monthly payment for principal and interest is $1,910, and the payoff date is in 2049 — the same year that Sally and Sam will celebrate their 75th birthdays.
The couple decides to accelerate their monthly payments. Doing so will enable them to collect a guaranteed, risk-free 4% rate of return. That’s because they’ll avoid the interest that would otherwise be charged on the principle that’s paid off early.
After reviewing their financial needs and goals, Sally and Sam decide they can afford to start paying $3,500 per month instead of the scheduled monthly payment of $1,910. This accelerated payment schedule will allow them to pay off their $400,000 mortgage balance in about 12 years at age 57, instead of paying it off in 30 years at age 75. In other words, they’ll avoid 18 years of interest payments.
If your financial situation differs from Sally and Sam’s situation, see “More Sample Scenarios” (below) to get an idea of how this strategy works under different assumptions.
Sticking to the Payment Plan for the Term of the Mortgage
The accelerated mortgage paydown strategy is beneficial for two main reasons:
1. Interest charges are avoided after the mortgage is paid off.
2. Debt is eliminated from your personal balance sheet.
Plus, you’re not required to stick to the accelerated payment schedule if your personal situation suddenly changes — for example, if you lose your job, a family member becomes ill and needs your financial assistance, or market conditions change. You can stop and restart the strategy anytime you want.
However, the biggest payoff from following the strategy will probably be reaped by those who have the cash flow and self-discipline to continue making accelerated payments even after the mortgage is extinguished. This involves taking the monthly amount that you previously dedicated to the accelerated mortgage paydown strategy and putting it into a retirement savings account (whether taxable or tax-advantaged).
To illustrate, after Sally and Sam pay off their mortgage in 2031, they plan to put $3,500 a month into a retirement savings account that earns 4% annually for another eight years. By age 65, they’ll have accumulated about $395,000 in the account.
Possible Downside
There’s one objection against the accelerated mortgage paydown strategy: You’ll lose tax deductions because your interest charges will go down more rapidly than if you stick to the scheduled payments. However, the Tax Cuts and Jobs Act (TCJA) imposes stricter limitations on home mortgage interest deductions for 2018 through 2025.
In addition, the TCJA nearly doubles the standard deduction amounts for 2018 through 2025. So many taxpayers who previously itemized deductions will now claim the standard deduction. Even if you’re still itemizing, the larger standard deduction reduces the incremental tax benefit from itemizing.
The bottom line is that, for many taxpayers, the home mortgage interest deduction isn’t as valuable as it was under prior tax law. However, the benefits of this deduction are scheduled to make a comeback in 2026, when the TCJA provisions will expire (unless Congress extends them).
Impact of Future Inflation or Deflation
While the accelerated mortgage paydown strategy will yield a guaranteed rate of return, it’s not foolproof.
If we have a period of high inflation, paying down a mortgage with a relatively low-interest rate earlier than required may no longer make sense. In this situation, it may be better to stop the accelerated paydown strategy, allow the mortgage term to stretch out and pay the remaining balance back with cheaper inflated dollars.
On the other hand, the accelerated paydown strategy will work great during a period of deflation. That’s because the mortgage is being paid down sooner when dollars are cheaper, rather than later when dollars are more expensive.
Let’s Talk
Does an accelerated home mortgage payment plan make sense for you? Contact your financial advisor to evaluate the pros and cons and estimate how much extra you could potentially save.
| More Sample Scenarios The main article presents a hypothetical scenario with the following facts:
Here’s what would happen if you tweak these assumptions. If Sam and Sally are ambitious and pay $4,500 per month, the couple will pay off their mortgage in just eight years! If they continue the accelerated payment strategy after the mortgage is paid off and put $4,500 a month into retirement savings account that earns 4% for another 11 years, they’ll accumulate about $745,000 by age 65. On the other hand, what if they’re less ambitious and decide to pay $2,500 per month? This will allow the couple to pay off their mortgage in just over 19 years at age 64. If they continue the accelerated payment strategy after the mortgage is paid off and put $4,500 a month into retirement savings account that earns 4% for just one year, they’ll accumulate about $55,000 by age 65. That’s more than enough to take their kids and grandkids to Disney World for a vacation when they retire. This strategy works for older couples, too. For example, Mark and Michelle are 55. Using the same mortgage terms, this couple decides to pay $4,000 per month instead of making the scheduled monthly payment of $1,910. They’ll pay off the mortgage in a little over 10 years, at age 66. That’s a lot better than having mortgage payments until they’re 85. |