Most homeowners have high hopes of paying off their mortgages quickly to avoid the monthly repayment to the bank but is it the right choice for their future?
Here are two reasons why people consider paying off their mortgage(s) early:
1. Financial: Basically, by paying extra on your mortgage payments or contributing to it with any means possible, you will save thousands of dollars on home loan repayments.
For example, say you receive a $100,000 mortgage from a bank with a 30 year amortization at 10% interest. Your monthly mortgage payment would be roughly $878 per month and it will not take you 30 years repay the loan and no longer have a mortgage payment.
However, since you are not only paying principle but interest as well on the $100,000 mortgage loan from the bank over 30 years the real cost will be $315,926. In total you end up paying an extra $215,926 more than the original $100,000 purchase price.
If you make extra payments throughout the loan period what difference will they have?
- Paying an extra $300 per month on your loan would save you $141, 410 in loan repayments over 30 years.
- Paying an extra $500 per month on your loan would save you $161,638 in loan repayments over 30 years.
- Paying an extra $1000 per month on your loan would save you $182,618 in loan repayments over 30 years.
Essentially, as you can see from the above example the more money you are able to put towards your mortgage amount every month will save you more money in the long run.
2. Peace of mind: Many people struggle with the thought of debt and the risk of losing their home if they are ever unemployed or in financial struggle. Paying off your mortgage more quickly ensures that you own your home sooner and thus cannot fear losing it. Especially if you are nearing retirement, it is an added bonus to be debt-free and use your savings for any unforeseen expenses that may occur or take that trip you have always wanted to go on!
The opposing view to paying off your home as quickly as possible is taking this money and investing it in which you could earn an income or a return.
So, the question is, which would you lean towards: paying into a mortgage with a high interest rate or into an investment fun that is bound to make a return?
The other option is to consider making a return.
By paying extra into your mortgage you don’t receive an income but you do save a large sum of money. The reduction in total interest expense means that you are effectively saving at an investment return of 10%.
Alternatively, if you invest this money in the stock market, you will only make a comparable return if the market return is at or more than 10%. If the market is more than 10%, it is potentially better to invest and earn an income than pay down your mortgage.
But how predictable can this be?
When you go to a bank and ask for a mortgage loan there are many variables and often times you are able to shop around for the lowest interest rate. Once you receive your mortgage interest rate it is set in stone and is unlikely to be changed by anyone. Interest is a bank’s main source of income thus mortgage rates will only change with the prime or federal interest rate.
On the opposite spectrum, the investing market can be very risky and unstable. The markets often rise and fall daily depending on economic conditions. This makes getting a guaranteed return very unpredictable and it is more of a gamble.
Investing in the stock market is really a game of risk. It requires careful consideration and research to choose stable investments that you are able to make a return on. Often times it can be a risky toss into the investment circle that can either result in great loss or victory in the return.
The question remains: Is paying off your mortgage early the right method. Here is a suggested approach to take when deciding which route you will follow:
Assess whether financial return or peace of mind is more important to you. If you want peace of mind than go ahead and pay off your mortgage with extra payments and become debt free.
If financial return intrigues you, make yourself aware of the uncertainty of returns. If you can find a relatively stable return with a great than 10% then paying off a mortgage can get pushed down on your list!