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The Opportunity Costs of Paying Off Your Mortgage Early

Consider a few other ways to spend — and grow — your money before aiming for mortgage zero.

June 30, 2021
in Investment, News, Wealth
0
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In the past year, the housing market has been on fire. As a result of the pandemic and historically low-interest rates, new home sales hit a 14-year high. The trend is expected to continue in 2021, with the National Association of Realtors reporting that 6.7 million new homes were sold in the United States in January, up 23% from a year ago.

You may feel both accomplished and overwhelmed as a new homeowner. However, a six-figure mortgage doesn’t exactly make you feel “wealthy,” so you might be following the popular financial advice of paying it off early. Is this, however, always prudent?

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Talaat and Tai McNeeley once told me that paying off their mortgage in five years provided them with more benefits than just interest savings. It gave me a sense of financial power. “We didn’t want to owe anyone anything,” says the group. It was all about “taking control of the aspects of our financial journey that we had control over.”

It’s a compelling argument, particularly for homeowners who are concerned about debt. In fact, according to a 2018 survey, about half of respondents planned to pay off their mortgage ahead of schedule, with the 40-something demographic leading the way.

I’ll admit that in my current life stage, this is something I’ve started to prioritize. I’ve agreed to put more money toward my principal in the hopes of owning our home in 20 years instead of 30. However, putting so much emphasis on your mortgage comes at a cost. I strongly advise you to do so only after you’ve checked off a few other financial boxes.

Boost your rainy-day fund. Check your rainy-day funds before aiming for mortgage zero. Is there enough money in the bank to cover your basic expenses for several months if you lose your job? The average “unemployment duration,” or the time it takes for someone receiving unemployment benefits to start working again, is 26 weeks. Before putting extra money toward your mortgage, you should have at least a six-month savings cushion.

Boost your retirement savings. It’s no secret that investing in the stock market yields a higher return over time than paying down a mortgage with a 3% interest rate. The numbers speak for themselves. Over the last 30 years, the S& P 500 has averaged an annual return of 8%. It simply makes more financial sense to put your retirement savings ahead of your mortgage.

Everyone’s retirement savings goal is different, but tools like and these can help you figure out if you need to increase your 401(k) or IRA contributions to stay on track. You’re one step closer to being able to pay off your mortgage sooner if you’re already contributing what you need to reach your goal and have extra money to spare.

Contribute to a college savings account. Investing in a 529 plan to help your child attend college with less debt (or debt-free) may be more financially rewarding than quickly paying off a mortgage. It’s fantastic if you can afford both without making a compromise. Take a chance. However, if you’re short on cash, I’d recommend prioritizing funding a college savings plan over making an extra mortgage payment. Again, the logic is that money compounding in a 529 plan will result in a higher return over time. It will also provide the financial benefit of helping a child through college.

The amount you contribute will depend on the type of school you want to attend (public or private) and whether you want to cover the entire cost or just a portion of it. Ron Lieber’s new book “The Price You Pay for College” is a great resource for parents navigating the costs of college.

Refinance and bank at a lower interest rate. Finally, before you decide to pay off your mortgage early, think about refinancing. Because refinancing “resets” the payoff clock, this may appear to be a step in the wrong direction, but bear with me.

You might be eligible for today’s ultra-low interest rate on a 30-year fixed-rate mortgage, which is around 2.8 percent if you have a good credit score in the mid to high 700s. If your current rate is closer to 4% and you plan to stay in your home for a long time, refinancing may be worthwhile — especially if the monthly savings from a lower interest rate will more than offset any upfront closing costs in a few years or less.

You can use this calculator to see if refinancing makes sense for you. If you answered yes, you could put the money you save each month toward the principal to help you get out of debt faster.

In the end, paying off your mortgage early can save you money in the long run, but it may come at the expense of other financial goals that provide more bang for your buck.

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