As mortgage rates have tumbled to levels not seen in decades, millions of Americans have rushed to refinance their homes. Generally speaking, this is probably a good idea; with a lower rate you’ll have more disposable income each month. And if you invest this money, you’ll really be putting your mortgage savings to good use. But what if you don’t want to simply refinance a 30-year mortgage? What if you want to replace your 30-year loan with one carrying a shorter term, such as 15 years? Or you may be thinking about simply making extra payments on your existing mortgage to pay off the loan earlier. Is this a good move?
It might be - but not necessarily from a purely financial point of view.
The question of switching from a 30-year mortgage to a 15-year one involves both financial and emotional issues - and, as such, there is no easy answer. Let’s look at the points to consider on both sides.
For many people, changing from 30-year to 15-year is simply intuitive: It just feels better to have a mortgage paid off sooner, rather than later. For most of us, a life without house payments sounds pretty appealing. And if you’re already in your mid-forties to mid-fifties, you may be especially keen on having your mortgage paid off as you enter your retirement years.
Furthermore, you can save many thousands of dollars in interest by paying off your mortgage early. Some people who seem to have difficulty finding money to put in investments look at paying more on their mortgage as a “forced” way to save and build equity.
Clearly, you’ve got some intriguing reasons to go from a 30-year mortgage to a 15-year. However, you can find some equally compelling factors for not making the switch.
For example, it may be great to save all those thousands of dollars in interest payments - but, at the same time, all that interest may be tax deductible. In fact, mortgage interest payments are the single biggest deduction that most people will ever have. So, once you’ve paid off your mortgage, you may need to find new ways to save money on taxes.
Also, every extra dollar you devote to paying off a mortgage early is a dollar you won’t be able to invest. Of course, there’s no guarantee on what type of investment return you might get from the money you might have put toward a mortgage. You may or may not beat the effective “guaranteed return” you get by paying off your mortgage. And yet, if you put these funds into a well-diversified portfolio containing high-quality investments, you could speed up your progress toward some of your important long-term financial goals, such as a comfortable retirement. With mortgage rates still at low levels, it is at least worth considering.
Building up your investments also may provide you with more financial protection and liquidity than paying off your mortgage early. If you encounter a severe setback - disability, job loss, etc. - you can always fall back on your investments until you regain your financial footing. But if the bulk of your assets are tied to your house, you might be forced to refinance or look at other options, such as a home equity loan or line of credit. These aren’t necessarily bad choices - your home equity loan or credit line may be tax-deductible, and the interest rate may well be quite competitive. On the other hand, you have to be sure you can afford the payments on these types of loans, because you’re essentially using your house as collateral.
So, there you have it: some sound reasons to pay off a mortgage early, and some sound reasons to keep paying on a longer-term mortgage and invest the difference. There’s no one “right” decision - but there’s a decision that’s right for you. Take the time to find it.