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We have interviewed several financial and mortgage experts to find out what they say is the best course of action when it comes to paying off a mortgage and what their reasoning is.
If you're in a position where you can pay more than what you're required to on your mortgage each month, that's great news. So you might be wondering whether you should pay more than the required minimum. You know that paying the minimum is not the best way to go with credit card debt, for example, because that debt is usually expensive. But mortgages are different. There are definite strategies when it comes to making mortgage payments. If you ask two experts what the best strategy is, you're likely to get two polar opposite answers.
Because this is a complex issue, we have interviewed several financial and mortgage experts to find out what they say is the best course of action when it comes to paying off a mortgage and what their reasoning is. It's up to you to ultimately decide what you think is best for your situation.
Gets rid of debt
Probably the main reason people pay extra on their mortgage loan is to get the loan paid off quicker. This makes sense if you're trying to get rid of all the debt you have. ''Paying your debt off at an accelerated pace is a very good thing if you are preparing for retirement and reduced income,'' says Casey Fleming, author of The Loan Guide: How to Get the Best Possible Mortgage . ''Having no mortgage when you retire is a very good thing. The most financially secure clients I work with are those with no mortgages (and an investment property or two).''
Reduces the interest you pay
You can save a considerable amount of money in interest payments by paying extra on your mortgage each month. ''Making extra home loan payments each month is a great way to save money through the life of a loan,'' says Michael Conner, a loan originator with Gateway Mortgage Group in Oklahoma. ''Making even a small principal payment could drastically reduce the overall interest you pay to your lender, and it will shorten the term of your loan.''
You can play around with particular figures by using our Mortgage Payoff Calculator. Here's an example:
You have a 30-year loan for $300,826 with a 4.5% interest rate. After six months, you decide to start paying an extra $150 each month. By making this one change, you would have reduced your loan term by 59 months (almost five years) for a total savings over the life of the loan of $46,111.
If you want to take this route, do so only if paying extra won't be a hardship on you. ''Make sure you are within your means and that you can afford to make the extra payment comfortably,'' says Conner.
But consider this: When you pay extra for one month, that doesn't reduce your payment for the next month. For example, if your mortgage payment were $1,000 a month, and you paid $1,200 in November because you had $200 extra money that month, you don't get to pay $800 in December when you might need more money. Mortgage payments don't work that way. If you pay $1,200 in November, you still need to pay $1,000 in December. ''When you pay extra on your mortgage loan, you see no real benefit unless you sell the home or pay off the mortgage completely,'' says Mark Ferguson, creator of Investfourmore.com.
Forces you to save
Some people can't resist binging on ice cream if they know it's in the house. And other people can't hold onto extra money if they know it's there. If every time you have some extra cash, you have to spend it, you might want to put that money toward your house instead. ''Paying extra on your mortgage may be a forced savings that works for you,'' says Ferguson.
Ties up money
If you have a 30-year mortgage, or even a 15-year mortgage, you will be paying it off quicker if you pay extra. But, depending on how much extra you're paying, you will still be tying up funds for quite a while. ''The money you invest in the equity of your home (by paying down your principal balance) is highly illiquid once you've sent it to the lender,'' says Fleming. So what's the problem with that, you may ask. ''Because it's hard to access, that money is no longer available for other investments that might earn you a higher return than what you are paying for the use of that money.''
Mark Ferguson agrees. ''You can finance a home for 4% or less in today's market. That is very cheap money.'' Ferguson likes to invest in rental properties. ''They have made me at least 15% return on my money. This is not for everyone, but some savvy homeowners may consider investing their money instead of paying off their mortgage early.''
You can get your money out of the home if you need to access it by refinancing. But that isn't always the best route. You might not qualify. If you lost your job or have too much debt, you might not be able to refinance. And if you can refinance, you will have to pay for the privilege. ''You are usually better off saving the money instead of paying down the loan and then refinancing,'' says Ferguson.
A lost tax advantage
If you're in a high tax bracket, you probably get some relief when you itemize your tax return and take the deductions to which you're entitled. And mortgage tax deduction is one of the main deductions people take. ''Paying down the balance reduces the amount of interest that you are charged, and therefore reduces your interest-related tax deduction,'' says Fleming.
As you can see, paying extra on your mortgage loan or paying only what is required is an individual choice that only you can make. If you do decide to pay extra, here are two important tips from experts:
Deb Tomaro , an Indiana real estate broker, says, ''Be sure to indicate extra payments are for principal. If you don't, it will just get applied to the next payment, and that doesn't help knock down your interest.''
Allison (DeYoung) Schmidt , a certified financial planner and CPA, says, ''Be sure to pay down your highest interest debt and establish an emergency savings account before making extra [mortgage] payments.''
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