In short, if you are a disciplined saver and investor with a low mortgage interest rate then probably not as there are several benefits to holding a mortgage. However, there are compelling reasons to prepay in certain circumstances – read below for more details.
Before we begin to get into the details, I am assuming we are talking about a typical 30-year fixed mortgage on your primary residence, and that you either purchased your home or were able to re-finance your mortgage in the last 8 or 9 years (during the very low interest rate environment).
One one hand, prepaying allows you to potentially save thousands of dollars in interest, shorten the duration of your loan and get closer to the day that you no longer have a payment! These are all great benefits but they don’t look at a mortgage in a strategic way. There are a few things to consider before writing that extra check:
- Better returns elsewhere.
- You probably have an interest rate that is around 3 – 5%. This is historically a VERY low interest rate and you can deploy your cash towards other assets that should be able to earn more than that rate. For example, the S&P 500 has historically returned around 10% prior to inflation. Meaning your return would be on average 5 – 7% better in the S&P 500 than paying down your mortgage.
- Inflation is your friend.
- When you are a debtor and have fixed mortgage payments, inflation will eat away at the purchasing power of those payments making them easier with each passing year. If inflation picks up, this makes it a no brainer to not prepay, but even if it stays low it will help if you plan to stay in your current home for a long time.
- Flexibility.
- If you prepay your mortgage that money is stuck in an illiquid asset. Stocks are easier to sell if you need to use some of the cash or convert it into something more liquid.
- Tax benefits.
- This one is a bit tricky due to the recent tax laws that were passed as now fewer Americans will be itemizing their deductions. If this is you, however, and you can itemize your mortgage interest than there is value in lowering you tax liability by keeping that mortgage payment. Effectively, your 3-5% mortgage rate may be 2-4%.
Major Caveats:
- If for whatever reason you were not able to re-finance and your rate is above 5% the reasons for prepaying your mortgage become more compelling.
- If you have the extra cash to begin with, you are probably disciplined enough, but if you will use that extra cash to splurge on luxuries instead of buying assets (e.g., stocks) – then go ahead and prepay the mortgage.
- You crave the stability of knowing you are getting a guaranteed 3-5% return versus an up-and-down market that in the long-term provides a higher return. This is a valid concern and you need to know yourself here. If the stock market fluctuations will prevent you from keeping you money invested properly (i.e., holding quality investments through bad markets) then you should prepay your mortgage. Improper investing practices in the stock market can definitely under perform a 3-5% return you get from prepaying your mortgage.
I hope this put prepaying your mortgage into perspective. It’s really a personal decision that is unique to each individual (which is why you should really consult a financial adviser for these big decisions) but this article should hopefully give you some food for thought. You can see that I think it’s better not to prepay – but there are several serious reasons why for some it is the right choice.
