Paying Off Your Mortgage vs Paying Down Your Mortgage
January 8, 2014
Should you pay off your mortgage, pay down your mortgage, or simply just make regular mortgage payments? This is a decision facing many of us because one of the biggest purchases we make in a lifetime is a home. Since few of us can afford to pay cash for a house, most of us use a mortgage for the purchase so the majority of homeowners owe money to a lender.
It’s been a long debate among professional money advisors on whether homeowners should suck up making the monthly mortgage payment, pay down, or pay off a mortgage early. The short answer is that it depends on the personal situation and financial situation you’re in as the homeowner.
Homeowner Situations
Financial experts and authors, such as Jane Bryant Quinn advise homeowners to stop considering their home as an investment vehicle and instead see it as a place to live. This is especially true if you are buying a starter home or just starting out with a mortgage, where your payments in the first few years are almost all interest anyhow.
If you’re halfway through your mortgage, such as the 15th year of a 30-year mortgage, you’re starting to reach the point where the proportion of the payment switches from mostly interest to mostly principal – thus reducing the mortgage balance.
In the recent turbulent times of the housing and lending market, many homeowners have found themselves owing more on their mortgage than their home is even worth. Most experts agree that defaulting on your mortgage and facing foreclosure is not the option to rectify the situation. If you are unable to obtain a mortgage loan modification with your current lender, continue to make the payments on your mortgage because each mortgage payment brings you closer to building more equity in the home and reaching the end of the mortgage.
Pay it One Way or the Other
Getting financial experts to agree on when a homeowner should simply make the monthly mortgage payment, when they should pay it down and when it may be beneficial to pay the mortgage off early is not a one-size-fits-all solution. The best-selling personal finance author Dave Ramsey suggests that homeowners should apply any additional money they can to paying down the balance on their mortgage. Other personal finance experts argue that a home mortgage is one of the biggest tax deductions most homeowners have.
When you do the math, however, your mortgage interest tax deduction may not be benefiting you as much as you think. Assume you are in the 25 percent tax bracket and pay $10,000 in mortgage interest during the tax year. This equates to a $2,500 tax deduction on your personal tax returns, leaving you with a difference of $7,500 ($10,000 – $2,500 = $7,500). If your mortgage is paid in full, then you would pay $2,500 more in income taxes, but you would be walking away with $7,500 more in your pocket.
The bottom line is that if you intend on living in the home for the long haul and you can afford to do so, the interest tax savings does not cancel out the interest you end up paying in the end. Experts also agree that you should focus on paying off high interest debt and debt that is not tax-deductible before focusing on paying off your mortgage.
3 Mortgage Pitfalls to Avoid
While it may be your goal to pay a mortgage off early, three mortgage-related actions to avoid include biweekly payment programs, pre-payment penalty fees and reverse mortgages.
Payment Program Fees
Biweekly payments, where you break your monthly mortgage payment into two payments, can help you to pay off the mortgage sooner. The problem is that this program typically requires an up-front fee that ranges from $200 to $400. You can accomplish the same goal by simply making one additional principal reduction per year or making additional principal payments with your normal mortgage payment.
Pre-Payment Penalties
If you do plan to pay your mortgage off early, contact your mortgage company about prepayment penalty fees. Most prepayment penalty fees occur if you pay the mortgage off or down within the first one to five years the mortgage is in place.
Reverse Mortgages
According to financial guru Dave Ramsey, a reverse mortgage is another pitfall to avoid because it puts you back in debt. In addition, the rates and fees on these mortgages can be very high. According to the Federal Trade Commission (FTC), reverse mortgages are one of the largest fraud outlets.
While a home purchase is one of the biggest purchases you make in a lifetime and it may be one of your biggest tax deductions, financial experts agree that if and when you can, paying off your mortgage makes sense. Make principal reduction payments, but avoid accomplishing your goal by using biweekly payment programs or incurring prepayment penalty fees.
While each personal financial advisor, accountant and family member may offer you an opinion on whether you should pay off your mortgage early, in the end you are the only one qualified to assess your personal situation and make the final decision.
Are you planning on paying off your mortgage early? Leave a comment and tell us why or why not!
This article was originally published August 4th, 2010.
All posts by Kristie
Kristie,
Even your simple analysis of the limited tax benefit of carrying a mortgage severely overstates the benefit.
From day one, the average American home-debtor sees little (if any) tax benefit from carrying a mortgage because: (1) their mortgage isn’t large enough; (2) their interest rate isn’t high enough; and (3) their other itemized deductions aren’t large enough to put their total itemized deduction above the standard deduction in any significant way.
The fact is that the mortgage interest deduction primarily benefits those who are extremely charitable and/or who have relatively expensive homes with large mortgages.
As Kathleen points out above, as the interest portion of a mortgage payment decreases, so does the tax benefit. And the fact that the standard deduction increases each year further decreases the tax benefit of a mortgage.
In short, most people overstate the tax benefit of their mortgage.
Great advice, thanks. I am at the point now that the interest paid on my mortgage (and other expenses) is not greater than the standard deductions – therefore no tax benefit. We are planning on paying off our mortgage soon.
This was a great and informative read!
Fabulous work by the author and creator!
Nice feedback from the readers as well!
Thank you for taking the time to share
this with us!