Paying off your mortgage as fast as possible is a very attractive prospect. Being debt-free as soon as possible? What’s not to like? When you pay off your mortgage early, you could save a tonne of money from interest, and you actually get to completely own your house. This is a great option for most people but if your finances aren’t in order, this could end up causing more problems for you. So, what actually happens when you pay your mortgage off early, and is it the right move for you?
Let’s start with a quick refresher. Every time you make a mortgage repayment, the amount you’re paying is split between the principal amount (the amount of money you actually borrowed) and the interest. During the first few years of the loan, most of the money you’re paying is going towards interest. Lenders are trying to make money so this shouldn’t really be surprising. But, as you get closer to the end of your mortgage, most of your repayments go towards the principal amount.
By making additional repayments you can reduce the amount of interest you pay, thus making it cheaper to pay off your mortgage. This could reduce your mortgage by years and save you thousands of dollars, potentially.
So, if you’ve got some spare cash around, should all of that go towards additional mortgage repayment? Like everything to do with finance, it isn’t that simple. There are risks and benefits to paying off your mortgage early.
You Have Other Options
Investing The Extra Money
Getting yourself out of debt as quickly as possible might not be the best thing for you. For instance, let’s say you’re about to make an additional repayment of $20,000 towards the principal amount. The original loan amount is $200,000 and you’re 20 years into the loan. The interest is 4%. You would save about $8,300 and be able to pay off your mortgage in 2.5 years earlier.
Sounds pretty good right?
But what if you invested that money? Put that money into an index fund on the U.S. S&P 500 with an average return rate on 9.8% which could earn you $30,900 in interest over the same amount of time left to pay off your mortgage (10 years). Even if the rate of the return was the same, 4%, you would still earn $12,500 in interest.
This doesn’t mean everyone should do this, after all you might not have any interest in investing, and you do simply just want to pay off your mortgage and own the house outright. Also, not everyone’s financial situation will be suited to this.
To check to see what your monthly repayments could be in order to pay off your mortgage faster, use our Loan Repayment Calculator.
Keeping Your Home Loan Active
Some people choose to keep their home loans active by avoiding paying their final balance and closing their home loans. But this only works if you have been making additional repayments into an offset account or redraw facility.
These offset accounts allow you to dip into them and make renovations on the property or even purchase a car. By keeping the home loan active, you still have access to that money which you can use to fund purchases for a lower rate than if you just took out another loan.
Keep in mind, that this only works if the annual fees and interest you’ll need to pay on the remaining amount is less than what you stand to benefit, if not, then simply pay off your mortgage.
There are few things that a lot of people tend to do wrong when trying to pay off their mortgage early. Here are a couple of things to watch out for.
Leaving Yourself Cash Poor
If you’ve thrown all the money you’ve had at the mortgage, then you won’t have any money left in case of an emergency. For example, if you get sick and can’t work for a few months, you might have nothing to live on for that time and be forced to take out additional loans in order to survive until you are able to return to work.
Not Checking If There’s A Prepayment Penalty
Lenders want to make money so if you’re paying off your loan earlier, then you won’t be paying as much interest, which is the main way lenders earn revenue. So, in order to make up for that loss, lenders will often charge a prepayment penalty. These can be equal to a percentage of the mortgage loan or the equivalent of a set monthly repayment. Ensure that you will be saving money on your loan by paying off your mortgage early.
If you are unsure that paying off your mortgage early is the right move for you, contact one of our brokers at It’s Simple Finance via email or phone.