A mortgage loan is a huge debt, and monthly repayments could be among the highest bills a household pays. Every borrower dreams of the day they no longer have to pay back their mortgage lender — it means owning their home outright, having more cash to play with each month, and even saving money on interest. Paying off your mortgage may be enticing, but is it a wise financial move to pay off all or even part of your mortgage early? Here’s what to consider if you have a lump sum and are thinking about using it to get rid of your home loan.
The popular personal finances guru Dave Ramsey has a strong dislike of all loans – including mortgages – and firmly believes that getting out and staying out of debt is the bedrock of financial maturity and growth.
And there are several reasons why Ramsey is correct.
- No debt means no interest payments.
- No debt means more of your monthly income becomes ‘disposable’ and free to invest and grow.
- Debt is addictive and can be used to prolong unsustainable spending and earning habits.
- It’s spiritually and emotionally healthy to not owe money.
So, from this perspective, it’s a no-brainer. If you can pay off your mortgage early, do it!
But my ‘mature loan’ is so valuable – I’ve paid so much interest already!
At this point, it’s important to clear up a common misconception. People think that a mortgage nearing the end of its life is worth more than a mortgage at its start. This often prevents people from paying down a loan that is nearly finished.
On a 30-year loan at say 3%, you will pay much more interest in year 1 than you will in year 25. But this is not because you are ‘pre-paying’ interest in the early years to finance the later years. You pay 3% interest on your balance every year. Since your balance in year 1 is much higher than in year 25, you pay more annual interest at the start than at the end. But in year 25, there is essentially no difference between your ‘mature’ mortgage and a brand new 5-year loan at 3%.
However, there are a number of counterarguments against paying off a mortgage early.
1) Opportunity cost
Despite recent interest rate increases and stock market woes, since 2008 mortgage interest rates have been between 2-4%, whilst stock market annual growth has been around 10%. Why take money to pay off a mortgage that is costing 3-5% when that same money could start growing today at a 10% return? Furthermore, as real estate becomes increasingly expensive, that money could go towards a down payment on a second home in Israel, the price of which increased by about 20% last year.
2) Paying down is easy, and remortgaging is complex
People often think that they can pay down a cheap mortgage and then borrow against their home equity if they later change their minds. This is true in theory but not in practice. The average home equity loan has an interest rate almost double a standard mortgage. Banks ask a lot of questions about the purpose of the funds which are not always easy to answer. As of October 2021, the Bank of Israel made it very difficult to borrow against an existing property in order to finance the purchase of a second home. Loan-to-value ratio requirements may prevent the bank from lending you anything at all. The above are just some of the complications that simply don’t apply to an existing mortgage that was taken to purchase a property.
3) Cash is king
Sometimes the best thing to do with a large chunk of money is nothing. Having a “rainy-day fund” or a liquid investment can give you the firepower to solve the money headaches that life throws at you, such as losing a job, replacing a car, unexpected medical bills, etc.
4) Use your money to change your life TODAY
Usually, mortgage loans are long-term products with low repayments. Repaying such a loan may free up some monthly cash flow, but it’s often not enough to really move the needle and change the quality of your life. However, starting an investment account, buying a second property, and investing in a new business, are all potentially life-altering changes. Having available cash to make one of these dreams a reality is a huge opportunity. Don’t waste it.
Paying off your loan ahead of schedule may help you save money in the long run, but it isn’t for everyone. As with most financial decisions, it’s complicated and personal. So, before you make any moves, you should think seriously about whether early mortgage repayment is a smart financial move for you.