When Not To Pay Off a Mortgage Early
Money Girl answers a listener question about paying off a mortgage early and explains when to do it–and 3 situations when it’s a bad idea.
A Money Girl podcast listener named Julie asks:
I have $20,000 that I’d like to use to pay down my mortgage balance, which is about $100,000, and has no prepayment penalty. What’s better–sending the full amount at once, or simply increasing my monthly payment over a period of time?
In this episode, I’ll answer Julie’s question, and discuss the pros and cons of paying off a home loan ahead of schedule. You’ll also learn about 3 particular situations when it’s a bad idea to pay down your mortgage early.
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Advantages of Paying Off a Mortgage Early
Let’s start by reviewing the main advantages of paying off a mortgage early. The most obvious benefit is that reducing the balance of a mortgage allows you to pay it off in less time, and to pay less interest over the life of the loan.
For example, if you owe $150,000 on a 30-year, fixed-rate mortgage at 5%, your monthly payment for principal and interest will be about $800. If you have the mortgage for 30 years, you’ll end up paying a total of $140,000 in interest.
But let’s say that after making payments for 4 years, you get a $20,000 windfall and decide to use it to pay down your mortgage. If you keep making the $800 monthly payment, you’ll pay off the loan in a total of 23 years instead of 30. Plus, you’ll cut the total interest that you have to pay from $140,000 to $98,000—saving about $42,000 in interest over the life of the mortgage.
Additionally, paying down a mortgage ahead of schedule means you have more equity in the home. Equity is the difference between a home’s value and what you owe. For instance, if your home is worth $200,000 and you owe $150,000, you have $50,000 in equity.
Having more home equity can help you qualify to refinance your mortgage for a lower interest rate, or to eliminate paying private mortgage insurance to your lender.
The main con to paying down a home loan early is that once you send the money, it’s tied up in your property.
Disadvantages of Paying Off a Mortgage Early
While getting out of debt sooner rather than later is generally a good idea, there are disadvantages to prepaying a mortgage that you should weigh carefully. Always consider your mortgage in the context of your entire financial situation.
The main con to paying down a home loan early is that once you send in the money, it’s tied up in your property. If you unexpectedly lose your job or suddenly have a large expense, you won’t be able to get that money back easily–if at all.
Money you send to a mortgage, either as a lump sum or by increasing your monthly payment, may be better spent on chipping away at more expensive, higher-rate debt, such as credit cards, payday loans, or student loans.
Additionally, you may be losing out on the opportunity to invest your extra money for returns that are higher than the rate you’re paying on your mortgage. For instance, investing in a mutual fund that pays you an average annual return of 8% is better than paying down a mortgage that costs you 5%.
See also: Should I Pay Off My Mortgage or Invest?
3 Situations When You Should Never Pay Down Your Mortgage Early
Having a paid-off mortgage is terrific—but not if it would leave you without enough available cash or a retirement nest egg.
Here are 3 situations when you should never pay down your mortgage ahead of schedule:
Situation #1: You don’t have emergency savings
Before you send one extra dollar to your mortgage, be sure to have plenty of cash in an FDIC-insured savings or money market deposit account. Make it a goal to always keep at least 3 to 6 months’ worth of living expenses on hand.
Even though you won’t earn much interest on your emergency savings, its purpose is to keep you safe if you get into an unforeseen financial hardship. Therefore, if you don’t have a healthy emergency fund, don’t even think about 
paying down your mortgage early.
Situation #2: You have high-interest debt
Never pay down a low-interest debt before a high-interest one. Tackling high-interest debts first saves you the most money in interest, which allows you to pay off lower-interest debts even faster.
As a general rule, mortgages are cheap money. Right now, the average annual cost of a 30-year fixed mortgage is 4.3%. (If you’re paying at least one percent more than the going rate for your type of loan, contact your lender about refinancing your mortgage at a lower rate.)
Additionally, you may be eligible to claim the home mortgage interest tax deduction, making your home loan cost even less on an after-tax basis. You never get a tax break for interest paid on other types of debt (except for a certain amount of student loan interest, if you meet income limits).
So why pay down an inexpensive mortgage when you could be using your money to get rid of outrageously high consumer debt or car loans instead?
Situation #3: You’re not investing for retirement
Investing for a comfortable retirement is one of the most important financial priorities we have. Using a tax-advantaged retirement account, such as an IRA or a 401(k) plan at work, will cut your taxes and turbo-charge your savings.
If you’re not saving a minimum of 10% to 15% of your gross income for retirement every month, then putting extra money toward a mortgage is a bad idea.
See also: Whether to Invest or Pay Down Debt
Should You Pay Down a Mortgage with a Lump Sum or Monthly Payments?
Now, back to Julie’s question. If her finances are in great shape with a fully-stocked emergency fund, no high-interest debt, and regular contributions to a retirement account, then sending money to her mortgage is a great idea.
Julie is wondering whether to make a big lump sum payment, or spread it out over time using a series of smaller payments. My answer: the faster you reduce your mortgage balance, the less interest will accrue.
For instance, making some assumptions about Julie’s loan shows that making a one-time $20,000 payment would likely save her about $40,000 in interest over the life of the loan. On the other hand, spreading it out and sending an additional $166 per month over a 10-year period would save her about $30,000 in interest.
Sending a lump sum amount to your mortgage always gives you the most interest savings; however, it’s riskier than sending a series of small additional payments, because you’re giving up a large amount of cash at once.
Also key: whenever you pay extra on your mortgage, be sure there is no prepayment penalty (as Julie mentioned), and that the additional funds will reduce your principal balance, not just get set aside to cover the next monthly payment.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
