Are you thinking of prepaying your mortgage? It might be a savvy move for some homeowners, but beefing up their loan payments just doesn't make sense for others. Here are the pros and cons cited by financial experts to help you decide whether prepayment is right for you.
Pro: Interest you owe will be lower
There is an extra fee you pay to the lender for loaning you the cash needed to buy a home known as the interest. Lenders are in the business to make money and hence, won't just hand out dough for free.
"Prepaying" your mortgage or increasing your monthly mortgage payments will effectively save you money in interest charges. Those savings will accumulate big-time.
For instance, you take out a $200, 000 mortgage with a 4% fixed interest rate on a 30-year term. Making the minimum monthly payments only will have you pay over $143, 739 interest over 30 years until the debt is paid off. Whereas of paying an extra $100 per month, you will save $27, 037 by paying $116, 702 only in interest over a 25-year time span.
Pro: Your mortgage will be paid off at a lesser time
Since you are accelerating the mortgage payments, you will shorten the time to pay off the loan which would let your cash flow increase in the future. Some borrowers will take this as a huge incentive.
A certified financial planner for Pitzl Financial, in Arden Hills, MN, Joe Pitzl, said that parents with young children who are concerned about paying for their college education in the future are recommended to increase mortgage payments. This way, their mortgage obligation is already gone by the time their kids head off to college.
Marguerita Cheng, a certified financial planner at Blue Ocean Global Wealth in Gaithersburg, MD, also says that you will also have peace of mind in paying more money each month toward your mortgage's principal. She said that it is emotionally gratifying to know that you’re able to pay your mortgage sooner than it’s originally planned.
Pro: Equity is built faster
Home equity is the current market value of your home minus the amount you owe on your loan regardless of how much money you put down on your mortgage. If your home is worth $250,000 with a mortgage balance of $200, 000, you'd have $50, 000 or 20% in home equity.
You would build equity faster by making larger mortgage payments toward your loan's principal. With higher home equity, you'll have a tremendous advantage in looking to get a home equity loan or home equity line of credit like paying for home improvements as mentioned by Tendayi Kapfidze, a chief economist at Lending Tree.
Pro: It improves your credit score
Your credit score can rise by showing that you have less debt and that you're responsibly handling debts in paying your mortgage off early. Since your credit score affects the interest rate you qualify for, this will be an advantage when planning to get a car loan or a second mortgage on a vacation home.
Con: Tax-deductible mortgage interest prepaid becomes reduced
It may not make sense from a tax-savings perspective when prepaying mortgage as it reduces your mortgage interest. Mortgages are designed to start off paying more interest than principal.
Let's say in the first year of a $300,000 loan, at 30-years with a fixed 4% interest rate, $10,920 will be deducted. (Punch your numbers into our online mortgage calculator to find out how much you paid in mortgage interest last year.)
However, itemizing deductions is required in taking a mortgage interest deduction under the new tax law and it may no longer make sense for most homeowners since the standard deduction jumped under the new tax plan to $12, 200 for individuals, $18, 350 for heads of households, and $24, 400 for married couples filing jointly.
Also, you could deduct the interest from up to $1 million in mortgage debt (or $500, 000 on single filing) in the past. But, only the interest on the first $750, 000 of mortgage debt is deductible for loans taken out from December 15, 2017, onwards, as stated by William L. Hughes, a certified public accountant in Stuart, FL.
Con: Missing more lucrative investment opportunities
Every dollar spent towards prepaying your mortgage principal is equivalent to every dollar you will miss investing in higher-yield ventures like stocks, high-yield bonds, or real estate investment trusts, says Pitzi.
Pitzi pointed out that this being said, you will be assuming more risk in investing your money in, say, the stock market instead of putting the money toward your mortgage.
Cheng added that risk tolerance has to be considered first in deciding where to put your extra cash.
Con: You may lose the opportunity of paying off higher-interest debts
Cheng said that for many homeowners, paying off higher-interest debt is more of value than prepaying their mortgage which includes debt from a credit card or a private student loan.
Consider this: Let's say you have a $400 debt in your credit card from month to month with a 20% interest rate, you'll be paying in a credit card interest of $80 per month. This would be leaps and bounds higher than the amount of money to pay in paying mortgage interest on a home loan with a 4% interest rate.
