It sounds smart on the surface: Pay your mortgage off early so you can free up cash flow, then effectively chop down your interest. But with today’s interest rates at historical lows, it’s hard to tell whether making such a move will be worth it. Is it smarter to cut the check and clear the debt for good? Or should homeowners stay the course and invest their extra cash in other assets?
“Most people are pre-programmed into thinking if I have extra money, I’ll put it in my house,” says Robert Stammers, director of investor education at the CFA Institute. “That was OK in the past because the interest rates were high, but these days it just doesn’t make sense. People need to think of the best place to put that money.”
We asked Stammers and real estate columnist Ilyce Glink to tell us the best and worst times to pre-pay a mortgage.
When to do it
You’re underwater. When a person is underwater, owing more than their home is worth, there’s no point in keeping that second loan around, says Glink. Even if the interest rate on the second loan is lower than the first, “paying off that second loan can really help people. This will provide more flexibility, just sending in that extra check every month,” she says. Ideally, you should aim to pay off the second loan within the next two to three years.
You’re fully invested in your 401(K) and Roth IRA. “If you have a certain amount of cash, and your’e not taking full advantage of it by putting that money in retirement savings, the money will be protected in bankruptcy” as opposed to your home, says Glink.
Homeownership is the dream. Some people feel a psychological benefit to saying they own a home. “On an emotional level, people feel really good when they pay it down,” says Glink, adding that “being without a mortgage is one of the dreams of homeownership.”
You’re nearing retirement. If you’re preparing to leave the workforce, it makes more sense to pay off your mortgage so you’re free and clear by that time, says Stammers. Not only will this provide more security and reduce home expenses overall, it will be easier to manage a fixed income.
When to hold off
You aren’t diversified. Yes, your home is your single greatest asset, but sometimes it makes sense to look at other assets to diversify yourself over time, says Stammers.
You’re deep in debt. If you’re living paycheck-to-paycheck or are carrying a large balance on your credit card then focus on improving your cash-flow instead, Stammers says.
You’re young. “If you have time to pay off the mortgage, don’t bother right away because you can invest in other things and spread the payments out,” says Stammers.
There’s no reliable income stream. Whether things are shaky at work or you’re burdened by debt, it doesn’t make much sense to throw cash at a home when you’ll likely need that money again, Stammers says. “Most people will get an equity line, etc. and have to take the money back out.”