Congratulations! You've bought your dream house, or maybe your first house, which is also a dream. Maybe you've bought a house that you plan to remodel one day, or one that you don't love but is home for now. Whichever the case may be, you have big choices to make. Do you pay off your mortgage over the life of the note or do you pay it down early? Because every home is an investment, the way in which you pay off your mortgage can have big impacts on your net worth over the long term.
What is your interest rate?
How much cash you give the bank every month for the privilege of borrowing their money should be one of the key factors you consider when determining how to pay off your mortgage. If you secured your mortgage in the past few years, you likely have a rate below 4-5%, which is generally considered very good. When financial planners estimate returns for other investments they generally assume something between 6-8%. At a very high level, you can assume that if your mortgage rate is 50% less than the average return in the market, it makes sense to invest your money elsewhere. Of course, like most things, it's not always that simple.
What is your family situation?
Are you a growing family, single person, or maybe a multi-generational family? All of these factors may change the way you look at your mortgage. If your family is established and you know that you will be living in your home for the long haul, it may change the way you view the mortgage. If you are approaching retirement, the monthly cost of your mortgage may be problematic on a fixed income. If you are a young professional and do not see yourself in the home long term, that too can be a major factor when deciding how to attack the mortgage balance.
What else should I be thinking about?
Generally speaking, carrying a mortgage is not a bad thing. If your rate is reasonable, you are saving for retirement in tax-advantaged savings plans like a 401k or IRA, and you have stable income, it may make sense to the carry the mortgage for the full term. This is particularly true if you are earning returns greater than your mortgage interest rate in your other investments. There are a few other things to consider when making this determination. First, mortgage interest is deductible if you are itemizing when filing your taxes. The standard deduction was recently increased as part of the new tax plan, therefore it is not as beneficial to carry a mortgage for most people than it used to be from a tax perspective. But if you are taking the standard deduction, you end up getting a large deduction whether or not you are paying mortgage interest, and in that case it is better to get the benefit without the cost of mortgage interest.
Are there other risks?
Yes, one thing many people forget is that when you "own" your home you don't "own" your home. What this means is that if you end up in a situation where you cannot pay your mortgage, it is possible that the bank forecloses. Whatever equity you have in your home at the time of foreclosure may be lost. If you are in an uncertain job market, a profession with irregular income streams, or some other circumstance you should understand that your home is not a bank account, because it can be taken from you. Also, homes are not liquid. If you need the equity from your home for some other reason, you will end up paying interest for the ability to borrow against your own equity in the form of a second mortgage or line of credit.
What about peace of mind?
This factor cannot necessarily be calculated and is an extremely personal reason for paying down a mortgage early. The idea that your home can be foreclosed for lack of payment is a reason for people to pay down their mortgage faster so that they are no longer beholden to their mortgage providers. For most people, the mortgage payment is the single largest cash outlay every month and eliminating that expense allows them to be more flexible in retirement, investing, and their professional life. Some people know that they won't realistically invest the additional money they would throw at their mortgage, so paying down their mortgage is a way to avoid lifestyle creep, while insuring a return of whatever their interest rate may be.
Paying off your home is an extremely personal decision and it is equal parts financial pragmatism and risk tolerance. Generally, you will never hear of someone that is upset because they chose to pay off their mortgage early. While they may have had a better return elsewhere, they now have peace of mind and the financial flexibility of more free cash flow. That being said, paying down your mortgage early does carry its own set of risks and can end up backfiring spectacularly in the event of a housing collapse.