Should I Pay Off My Mortgage Early?

I’m always fascinated by the question, “Should I pay off my mortgage early?” 

People usually fall into three camps:

  1. YES! Pay it off. Debt is bad. You’ll never regret paying it off. 
  2. No, you should invest the money. You’ll earn more in the market. 
  3. I’m asking the question because I don’t know. 

I’m fascinated because I don’t know how anybody can answer for another person without knowing more about them. I’m not sure how one answer makes sense for another person every time

This is a nuanced question. It’s also a loaded question. 

I’m not going to tell you whether you should pay off your mortgage early, but I am going to give you a framework for how you can think through the decision. 

As much as people want to make it a simple question with a simple response, it’s a complicated question with a range of answers that could all be correct. 

If you are looking for a straightforward answer, this post is not for you. 

If you are looking to understand what it actually means to pay down your mortgage early and establish a framework for how to think through the question for you now and in the future, this is the post for you. By the end, you should be able to decide for yourself if paying your mortgage off early makes sense. 

Plus, I’ll also share how I am approaching the question of paying off my mortgage early.

What is a Mortgage?

I know you probably already know what a mortgage is, but sometimes the best way to break down a question is to define everything to its simplest form. 

A mortgage is a loan between you and a lender to purchase a property. A mortgage loan is a “secured” loan, meaning it is backed by an asset. In this case, it’s backed by the home. The home acts as collateral in the event you do not make a payment on your mortgage.

Put simply, someone lends you a bunch of money you may not have to buy a home and in return, you pay them monthly payments for a set period of time, usually 15 or 30 years. It’s a way to own an asset you otherwise may not be able to afford. 

What Happens When You Pay the Mortgage?

Each time you make a payment, you are paying down your loan; however, it’s important to know that each payment you make does not reduce your mortgage dollar for dollar.

For example, if you had a $300,000 mortgage and paid $2,000 as a monthly payment, your loan is not $298,000 now. 

A portion of each payment is paid towards principal and interest.

Side Note: If you elected to include property taxes and insurance in your payment, a portion also goes towards escrow to pay for those. 

For simplicity, let’s assume you don’t pay your property taxes and insurance through your mortgage payment and instead pay them separately. 

Using the example before, a portion of the $2,000 goes towards the principal, which does reduce the loan value dollar for dollar. 

A portion also goes towards interest, which does not reduce the loan value. 

Let’s look at a real-life example. Let’s say you have a 30 year fixed, 3% rate $300,000 mortgage. 

Your monthly payment would be $1,264.81 for 30 years at which point, the $300,000 loan would be paid off and you would own your home free and clear. 

Since mortgage loans are amortized, meaning a portion of each payment goes towards principal and interest, payments early in your loan go more towards interest than principal. 

Conversely, your last few payments are going mostly to principal and very little interest. 

For example, in the case of the $1,264.81 payment, your first mortgage payment would be $750 of interest and $514.81 of principal. After the first payment, your loan balance is only reduced by $514.81, bringing it to $299,485. You can do the calculation for your own loan here:

You paid $1,264.81, but only reduced your loan by $514.81. Where did the rest go? 

Interest – remember you are paying 3%, and interest is front-loaded on the loan. 

Contrast your first payment to your last payment when $1,261.66 is applied towards the principal and only $3.15 goes towards interest. 

When you make a payment, remember:

  • A portion goes towards principal and interest. 
  • More of your payment goes towards interest in the beginning of the loan. 

This will be important to remember later. 

What Type of Mortgage Do You Have?

Now that you know more about how mortgages work, you need to understand what type of mortgage you have. 

The type and term are two important pieces of information.

There are mainly two types of mortgages: adjustable-rate mortgages (ARMs) and fixed. 

They are how they sound. 

Fixed mortgages have a fixed rate for the term (or length) of the mortgage.

ARMs have rates that adjust, usually after a set amount of time. 

Fixed-rate mortgages are a good way to lock in your payment for a long period of time. It gives certainty. 

ARMs usually have lower rates than fixed mortgages, which means they might allow someone to have a lower payment than a fixed-rate mortgage or afford a more expensive house. 

The other important piece of information to have is the term of the mortgage.

For fixed-rate mortgages, it’s usually 15 or 30 years. You can get 10 and 20-year mortgages, but they are rarer. 

For ARMs, it’s usually a 30-year mortgage, but you’ll see them presented as 3/1, 5/1, 7/1, or 10/1 ARM usually. 

The first number is how long the rate is fixed in years. For example, a 10/1 ARM has a fixed rate for 10 years and then the rate can adjust, which could potentially increase your payment. The “1” means the rate adjusts annually after the fixed period.

Take note – what type of mortgage do you have and what is the term? 

Tax Benefits of a Mortgage

A mortgage is tax-deductible, right? 

People love to fall back on this line of reasoning. “At least it’s tax-deductible”, they will say. 

It could be tax-deductible, but it may not be tax-deductible in your situation. 

When the Tax Cuts and Jobs Act was passed in 2017, the standard deduction was raised, which made it harder for people to itemize their deductions. For example, in 2022, the standard deduction will be $25,900 for married couples filing jointly and $12,950 for single filers. 

What this means is that mortgage interest, state and local taxes, charitable deductions, and any other itemized deductions have to add up to more than the standard deduction for your mortgage interest to actually be tax-deductible.

For example, if you were married filing jointly, and had $8,000 of mortgage interest, $6,000 of state and local taxes, and no charitable contributions, you would only have $14,000 of itemized deductions, which is less than the standard deduction of $25,900. This means you would take the standard deduction.

In this scenario, your mortgage interest isn’t giving you any tax benefit. 

While a mortgage can provide tax benefits, it’s much harder to see any benefit given the higher standard deduction. 

Also, since a mortgage is amortized, you are going to have more mortgage interest that could be tax-deductible near the beginning of the mortgage than at the end. Said another way, even if you could itemize deductions, the amount of mortgage interest you are paying in the last few years of the mortgage is usually of very little benefit. 

That’s something to note as you decide for yourself whether it makes sense to pay off your mortgage early. 

What is Actually Happening When You Pay Extra on Your Mortgage? 

Let’s say your mortgage payment is a $1,264.81 payment to continue the example from earlier. 

What happens if you pay more than that amount?

First, you’ll want to specify that you want it to go towards your principal. If you don’t, they may apply the payment towards your next monthly mortgage payment. 

When you pay extra towards your principal, you are paying down your loan, which means it will end sooner and you’ll pay less in interest. 

Another way to look at it is that you are locking in a certain rate of return on your “investment”, which in this case is the payment towards your mortgage. 

For example, if your mortgage interest rate is 3%, you are saving yourself 3% on the extra money you paid towards the principal. 

In that example, a 3% rate of return is neither good or bad. It’s just what is happening what you pay extra towards your mortgage loan. 

You are also putting more money into an illiquid asset (your home). 

It’s important to recognize that you are exchanging a liquid asset (cash) for an illiquid asset (your home). They are both assets, but they function very differently in your financial life.

Cash could be invested in the market, used for a vacation, or used to start a business. 

The equity in your home is harder to access. You can use HELOCs or do a cash-out refinance, but for the most part, you are putting money into an asset that is not easy to use unless you sell it. 

Remember, when you pay extra towards your principal, you are:

  1. Locking in a rate of return (your mortgage interest rate) on the amount you pay, which you can view as an investment. 
  2. Shortening the loan term and reducing the amount of interest you’ll pay over the life of the loan. 

If you want to calculate how much in interest you can save and how much sooner you’ll pay off your mortgage, you can use this calculator.

Bringing it Together – Answering the Question “Should I Pay Off My Mortgage Early?”

Now that you know how a mortgage functions and what happens if you pay extra, let’s bring it together with a framework for deciding if you should pay off your mortgage early. 

There are two options:

  1. You pay your mortgage as scheduled for the entire term. 
  2. Pay extra along the way or make a lump sum payment to pay it down more quickly. 

If you pay your mortgage as scheduled, but have extra money left over, you could invest that amount or use it to enjoy life. 

I can’t tell you how much joy the extra money will bring or how to measure how much benefit that adds to your life, but it’s a consideration. What if you spent the extra $100, $200, or whatever amount to enjoy life with your family? 

How would an extra trip while your kids are young impact your life? 

Don’t let the top five regrets of dying be your top five regrets.  

The other option is to invest the money. This is a common argument for why people say not to pay extra towards your mortgage. In today’s low-interest rate environment, your mortgage interest rate represents a low hurdle rate.

What I mean by that is that historically, stock investments have returned 7-12%, depending on the time frame. If your mortgage is only 3%, historically, there are good odds investing the money will earn you more money than the money you would have saved paying down your mortgage. 

It won’t happen in every time period and there is still a chance it won’t happen over time, but history is on your side. 

However, if you have a conservative portfolio with only 20% in stocks and 80% in bonds, that might be a reason to pay down your mortgage more quickly. With low-interest rates, that portfolio may not earn more than 3% over time, which means you could potentially save more money by paying down your mortgage instead of investing it. 

Another reason to possibly pay off your mortgage early is if you have an ARM and are worried about rates rising. By paying more of it down early, you are shortening the loan, which means you are less exposed to changes in rates and a potentially higher payment. Another option is to invest the extra money and have it as a side fund that could be used to pay off more of the mortgage if your interest rate does increase.

I’ve tackled this purely from a mathematical perspective so far. 

Life does not operate in a mathematical vacuum. We are emotional beings. 

If you decide to invest the money instead of paying down your mortgage and the market goes down 40%, that may not feel very good. You may be tempted to then take the money that declined 40% and use that to pay down your mortgage.

Historically, that’s one of the worst things you could do because markets normally recover if you own a globally diversified portfolio. 

When that happens, you may think, “I could have earned 3% paying down my mortgage, and now I am down 40%!” 

Remember when investing, it’s a game of time. 

The longer you stay invested, the higher your likelihood of success, which is why someone who has 29 years left on their mortgage has a good chance of earning a higher rate of return investing than paying down their mortgage.

If someone only has five years left on their mortgage, the decision becomes more complicated. Markets have a much greater range of returns in a five-year period than they do over 29 year periods. 

Lastly, I’ll end with a psychological component. 

Being debt-free can be extremely uplifting. There is a grand feeling of having your house paid off. People will have parties to celebrate paying their mortgage off. 

That may be a greater benefit than earning a higher rate of return by investing extra money. 

As you think about the decision to pay off your mortgage early, below are a few questions to help you decide for yourself. 

  1. Am I okay taking a liquid asset (cash) and converting it to an illiquid asset (your home) that is usually only accessible when sold? 
  2. Is my mortgage fixed or could I potentially have a higher payment later with an ARM?
  3. If I don’t pay extra on the mortgage, will I use that money wisely? 
    • This could be to enjoy life, invest the money, or many other things. 
  4. If I invest the money, am I committed to leaving it invested? 
  5. Is the money invested likely to earn a higher rate of return than my mortgage, given the time I have left on the mortgage? 
  6. Will investing the money stress me out if the market goes down and the rate of return I earn is less than the mortgage rate for 5+ years? 
  7. Am I actually receiving a tax benefit with the mortgage interest I pay?
    • Keep in mind the higher standard deduction and that later in your mortgage, the mortgage interest is less. 

Summary – Final Thoughts

The decision to pay off your mortgage early is not an easy one. There is the economic decision of paying extra, but there is also the psychological aspect. 

Just because someone else pays off their mortgage early does not mean you need to pay yours off early. 

Just because someone does not pay off their mortgage early does not mean you can’t pay yours off early. 

Both decisions can be valid under many different circumstances. 

Personally, I’m not paying extra on my mortgage. I have a rate below 3% and am willing to leave the money invested for 20+ years. Plus, I am currently building a business, which means I don’t have regular employment income to apply to the mortgage. Even if I did, I don’t think I would be paying extra right now.

Although I’m not actively paying extra, I have paid extra on my mortgage here and there, but not as a long-term strategy to pay it off by a certain date. I did it because I was comfortable earning around 3% at the time by paying it down. 

Economically, I feel confident I’d be better off investing it, but psychologically, it was nice to see the principal amount go down at that moment. 

Whatever you decide, make sure it’s your decision and you are not blindly following someone else’s guidance that may not have similar circumstances to you or think in a similar way to you. 

Disclaimer: This article is for general information and educational purposes only and should not be considered investment, financial, legal, or tax advice. It is not a recommendation for purchase or sale of any security or investment advisory services. Please consult your own legal, financial, and other professionals to determine what may be appropriate for you. Opinions expressed are as of the date of publication, and such opinions are subject to change. Click for Full Disclaimer