Whether you should pay off your home loan early or not is a topic of perennial debate. It depends on a number of factors including your financial situation and retirement plan. Read on to find out more.
If I have to pick the most disturbing word in the English language, it has to be ‘mortgage’ hands down. The word comes from a French term used in Britain in the Middle Ages meaning ‘death pledge’. This pledge only ends when either the obligation is fulfilled or the property is taken through foreclosure. Yep, I know. It’s pretty f***ed up given that almost everyone has to take out a mortgage to buy a home these days. We are practically slaving away just to have a place to live!
A mortgage is a significant financial burden on your shoulders and you carry it for decades. As a homeowner, the idea of having your home fully paid off is extremely appealing. But is it always better to clear your mortgage as quickly as possible? As with every financial decision, you should definitely consider all factors before settling on a course of action. This article covers:
- The Pros and Cons of Paying Off Your Mortgage Early
- Questions to Ask Yourself before Paying Off Your Mortgage Early
- Five Ways to Pay Off Your Mortgage Early
1. The Pros and Cons of Paying Off Your Mortgage Early
Let’s start by weighing the main advantages and disadvantages.
| Pros | Cons | |
|---|---|---|
| 1 | You no longer need to make monthly mortgage repayments | You cannot use the money for other investments |
| 2 | You save money on interest | You lock a good chunk of your net worth in your home |
| 3 | You don’t have to worry about rising mortgage interest rates | You might incur mortgage prepayment penalties |
| 4 | You own your home outright | You don’t get to enjoy mortgage interest tax deduction |
Pro 1: You no longer need to make monthly mortgage repayments
It goes without saying that paying off your mortgage ahead of schedule reduces your monthly expenses and frees up cash for you and your family each month. The money could be used for other things such as stock investment or your child’s education. With better cash flow, you will also have less stress when you are hit with unexpected expenses.
Pro 2: You save money on interest
The amount of interest charged to your mortgage can be pretty significant. That’s why it is important to be prudent and not overstretch yourself when buying a property. This way, you might be able to opt for a shorter loan tenure and save tens of thousands of dollars. Here’s a simplified example using PropertyGuru’s mortgage calculator:
30-Year Loan Tenure Loan Amount: $1.5 million Interest Rate: 3.0% per annum Total Interest Repayment: $776,661 20-Year Loan Tenure Loan Amount: $1.5 million Interest Rate: 3.0% per annum Total Interest Repayment: $496,522 You Save: $280,139 Assumption: The interest rate is fixed at 3.0% per annum throughout the loan tenure and the principal amount gets paid down from the start.
Clearly, the sooner you eliminate your mortgage, the less interest you incur. However, if you’ve already committed yourself to a loan and wish to speed up your repayments, you’ll need to factor in possible mortgage prepayment penalties. See Con 3.
Pro 3: You don’t have to worry about rising mortgage interest rates
A home loan is generally considered a good debt. First, there’s a chance that your property will appreciate in value and you get to enjoy capital gains when you eventually sell it. Second, you can leverage low mortgage interest rates to finance your property.
For the longest time, interest rates had remained near historic lows and this boded well for homeowners. Then, soaring inflation and escalating interest rates hit us like a ton of bricks this year (2022). When interest rates go up, mortgages become more costly. For example, customers of Singapore’s three major banks got a rude shock on 4 October 2022 when the mortgage fixed interest rates in Singapore went up to 3.85%. With every interest rate hike, homeowners have to brace themselves for higher mortgage repayments. Hence, if you have the money, you might want to make partial repayments to cope with rate volatility or even clear your loan once and for all so that you don’t ever have to worry about rising mortgage interest rates again.
For the longest time, interest rates had remained near historic lows and this boded well for homeowners. Then, soaring inflation and escalating interest rates hit us like a ton of bricks this year (2022).
Pro 4: You own your home outright
Life is unpredictable. Some day, you might find yourself in a financial tight spot, e.g. retrenchment (I hope not), and struggle with your monthly mortgage repayments. If you fail to meet your obligations stipulated in the mortgage agreement, the lender will initiate a foreclosure on your home. But when you completely own the home, there’s no chance of losing it. That’s why clearing your mortgage is so liberating. It gives you peace of mind. You can sleep soundly at night knowing that the ‘death pledge’ is gone. Small wonder many people aim to crush their mortgage when they are approaching their retirement years. It makes sense to get rid of all your debts when you’re no longer drawing an income from full-time employment.
BUT let’s look at the other side of the coin before making any hasty decisions.
Con 1: You cannot use the money for other investments
If you’re thinking about paying off your mortgage early, it might be worth considering the opportunity cost — whether the funds could give you higher returns elsewhere, e.g. invested in the stock market. There’s a high probability that the rate of return earned from investing would surpass the interest saved on the mortgage.
It might be worth considering the opportunity cost — whether the funds could give you higher returns elsewhere, e.g. invested in the stock market.
Let’s assume that your mortgage interest rate is 3%. In comparison, the S&P 500 has gained around 10.7% on average annually since it was introduced in 1957, and about 14.7% over the last 10 years. So if you have the funds to pay off your mortgage 10 years earlier, you’ll most likely do a lot better by investing the money in the stock market for that duration. If you don’t have the stomach for the stock market, there are less risky investments, e.g. fixed income, that could potentially give higher returns than the cost of your mortgage.
Con 2: You lock a good chunk of your net worth in your home
What if you hit a financial rough patch and need liquidity? Your home is an illiquid asset and tying up your savings in it can be problematic if you urgently need money. The last thing you want is to max out your credit card or try to take out another loan. You should therefore set aside an emergency fund (at least six months’ worth of expenses if not more) before thinking about clearing your mortgage.
Con 3: You might incur mortgage prepayment penalties
Mortgage lenders make money by charging you interest on your loan. Thus, you’re essentially costing your lender money when you pay off your mortgage before schedule. To recoup their losses, most lenders charge prepayment penalties. If you’re still within the lock-in period, you will have to pay a penalty (usually a percentage of the prepaid sum). This obviously wipes out some of the interest savings you want to gain from prepaying your loan. Nevertheless, do note that some lenders will allow you to prepay your mortgage up to a certain amount a year without penalising you. You should definitely check with your lender about the charges before making any prepayment.
Note: For Singaporeans with HDB loans, you’ll be happy to know that HDB is more relaxed than banks. There’s no prepayment penalty if you wish to clear your mortgage early.
Con 4: You don’t get to enjoy mortgage interest tax deduction
This is a major consideration if you’re an American. As a homeowner in the US, you can lower your taxable income by taking advantage of the mortgage interest deduction. From what I understand, the current mortgage deduction limit is $750,000 for a single filer or married couple filing jointly. For married taxpayers filing separately, the deduction limit is $375,000 for each party. You’ll lose this benefit if you pay off your mortgage early, so do think about it carefully especially if the deduction keeps you in a lower tax bracket. Consult a tax accountant if you’re not sure.
Here in Singapore, homeowners don’t get to enjoy such a perk for their primary residence. But if you’re a landlord, you can make use of a number of property tax deductions including claims on mortgage interest, maintenance and expenses incurred in obtaining rental income. No wonder so many Singaporeans dream of becoming a landlord despite the obscenely high prices!
2. Questions to Ask Yourself Before Paying Off Your Mortgage Early
I know there’s much to mull over. Before taking the leap, you should definitely ask yourself the following questions:
► Are you in good financial shape? Do you have ample liquidity for unexpected expenses if you pay off your mortgage early? Have you set aside funds to keep you going for at least six months in case of emergency?
► Do you have other more expensive debts such as credit card bills and unsecured loans? You might want to settle these high-interest debts before thinking about clearing your mortgage.
► If you don’t pay off your mortgage early, how will you use the money? What are your alternatives? Are you going to invest the money for better returns? Are you a savvy or clueless investor? Be realistic about what you’re likely to do with your money. If you’re just going to leave it in your bank account and earn measly interests, you might be better off crushing your mortgage.
► What will you gain from paying off your mortgage early? How much interest will you save after deducting the prepayment penalty, if any? How will your monthly cash flow improve? What are you going to do with the spare cash?
► What are the intangible benefits of paying off your mortgage early? How much do you value freedom, security and peace of mind? Emotional benefits cannot be measured in strictly financial terms, but they might be very important to you.
3. Five Ways to Pay Off Your Mortgage Early
If you’re sure about paying off your mortgage early, here are a few steps you can take:
1️⃣ Increase Your Monthly Repayment Amount
If you have some spare cash every month, you might want to increase the amount you repay to your lender. For instance, if your monthly mortgage repayment is $2,275, you could round it up and pay $2,500 instead. You will barely notice the slight increase in expenses.
2️⃣ Make More Frequent Repayments
Instead of making monthly repayments, you could switch to a fortnightly schedule. By doing so, you will be paying down an extra month each year.
3️⃣ Make Lump Sum Repayments
You could also make lump sum repayments, e.g. with your year-end bonus. These extra repayments can have a significant impact on how quickly you pay off your mortgage. You should check with your lender to see if there’s a limit on how much you can prepay in a year.
4️⃣ Consider Refinancing
Sometimes, refinancing might make more sense than clearing your mortgage. You could get a lower interest rate to reduce your monthly repayments, thus giving you more liquidity. You could also opt for a shorter loan tenure, e.g. a 15-year term instead of a 25-year term. By doing so, you will not only save yourself a fair chunk of interest, but also eliminate your mortgage sooner. Some homeowners also refinance to improve their cash flow by extending their loan term. You probably wouldn’t want to do that if your objective is to accelerate your payoff.
5️⃣ Consider Downsizing
As you approach retirement, you might want to sell your home and move into a smaller and more manageable place. By downsizing to a smaller home, you could possibly crush your mortgage once and for all and even make some money. This way, you do not need to tap into your savings, which could be invested for higher returns. The move will also boost your finances in the long run as a smaller home often means smaller bills (lower energy consumption, less maintenance costs, etc.).
To sum up, there are multiple factors to consider before paying off your mortgage early, so don’t jump the gun. Every situation is different and you need to figure out what’s best for you. Ultimately, the decision comes down to personal preference and how it can help you achieve your financial goals. If the numbers make sense and you feel good about it, it’s probably the right decision.
Thinking of downsizing to a smaller home to become mortgage-free? Mr Wow and I did just that in 2018. Read on to find out more.
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