Does it Make Sense to Pay Your Mortgage Down Early?

Every month, my mortgage company gives me the same offer: Would I like to pay a little extra to lower the debt on my home mortgage? Even small additional payments, made over time, could chop years off the time it takes to repay my home loan, according to the bank.

It always seems like a virtuous, prudent thing to do - but it almost never makes good financial sense, according to a recent breakdown of the numbers in the New York Times.

It turns out that with interest rates so low, relatively few people benefit financially by paying off their home loans early, at least compared to their other options. The rest of us are much better off taking our surplus cash - if we have surplus cash - and investing in something like a retirement account or a health savings account, particularly if that investment is also tax deductible.That's because if you have surplus cash to put towards your mortgage, you've probably already been able to refinance your loan and fix your interest rate at about 5 or 6 percent. (If you're still suffering with a 7 or 8 percent interest rate, here's an article to help you think about refinancing.) Your effective interest rate could also be a few points lower if you figure in the money you save on taxes because interest paid on a home loan is tax deductible. For example, if you're in the 25 percent federal tax bracket, a 6 percent mortgage might be costing you just 4.5 percent, if you itemize your income tax deductions, according to this breakdown of the number from MSN Money.

Your particular tax situation can make a big difference, so check your tax form or ask a tax specialist how much the mortgage interest deduction effects your tax bill, compared to the standard deduction that everyone gets. Compare the money you save in taxes to the mortgage interest you pay every year to figure out your effective interest rate.

Anything that you do with your surplus money that yields better than the interest rate on your home loan will be a better deal than paying off your loan.

Even in tough financial times, it is possible to find relatively safe investments that yield 4 or 5 percent, especially if that investment is tax deductible and you can afford to keep the money invested for a significant time without being forced to sell at a low point. If you still have some years between you and retirement, consider adding to your retirement funds - and include the tax deductions and any matching contributions from your employer into your math as you compare that investment to paying off your mortgage.

As you do your comparison, remember that real estate is not a liquid asset. Just because you put money into your house, that doesn't mean you can get the money back out if you need it.

Could you be one of the few who does benefit from paying off their home loan faster? It depends on your financial goal. If your top financial priority is to live totally debt-free, you have income to cover your expenses for the foreseeable future, and you've knocked out all your higher-interest debt, paying down your home mortgage will help you meet that goal. A number of people approaching retirement match that profile, and if you're one of them, here are some mortgage calculators to help you count the days to a life without debt. Many of us, however, are better off keeping that cash in reserve.
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