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You may be inclined to pump extra money you have into your mortgage. But read on to see why that’s really not your best move. [[{“value”:”
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It’s a common thing to sign a 30-year mortgage when buying a home. But the idea of having a mortgage hanging over your head for three decades may not be ideal. So you may be motivated to make extra mortgage payments in the hopes of paying it off early.
That’s not an unusual thing to do. But depending on your circumstances, it might also be a huge financial mistake.
Why paying off a mortgage early doesn’t always make sense
The logic behind paying off a mortgage early is simple. The sooner you do, the less interest you pay. But if you have a low interest rate on your mortgage, then it doesn’t make sense to pay it off early. In doing so, you could actually end up losing money.
In 2020 and 2021, mortgage rates fell to record lows. If you signed your mortgage then, you may have locked in a fixed interest rate of 3% or less.
But right now, savings accounts are paying 4% or more just to keep your money in the bank. So why would you pay extra into your mortgage to save 3% interest when you could earn 4% interest on that money without taking on any risk?
Plus, if you leave more money in your savings account rather than pay it into your mortgage, you’ll have more of a cushion in case your home needs repairs. Borrowing rates are up these days. So if you end up needing to do a $10,000 repair, you might get stuck paying 7%, 8%, or 9% to borrow that money in the form of a home equity loan.
But if you don’t pay extra into your mortgage and keep your cash, you’ll have the money to cover repairs outright.
Investing is a better idea
Furthermore, on a long-term basis, investing your extra money rather than paying off your mortgage early could do better things for your finances.
Say you took out a $200,000, 30-year mortgage three years ago at 3%. A one-time extra payment of $5,000 into your mortgage now will save you about $6,000 in interest and shave about a year off of your repayment window.
But let’s say you instead invest your $5,000 in a portfolio of stocks. At a 10% return, which is in line with the market’s average, you’re looking at growing your balance to about $65,000 over 27 years — the remaining time on your mortgage. That’s a $60,000 gain, which beats saving $6,000 on interest costs.
Hold off on extra mortgage payments even if your loan’s rate is higher
If you signed your mortgage in the past couple of years, then you may be sitting on an interest rate around 7% instead of 3%. If so, you might assume it makes sense to chip away at that loan because of that much higher rate. But even then, you may want to hold onto your cash.
If you signed your mortgage recently at a higher rate, there’s a good chance you’ll have an opportunity to refinance in the coming years as rates start to drop. So if you make a point to maintain a great credit score or boost your score into a more favorable range (ideally, the mid-700s or higher), you can put yourself in a position to lock in a lower interest rate on your new loan.
From there, you may be looking at paying a lot less interest overall, which is often the goal of paying off a mortgage early.
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