Making Extra Mortgage Payments? Not So Fast

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Editor’s note: This column has been updated from an earlier version.

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You recently bought a home. Congratulations. Your new mortgage company just sent you a payment statement, which includes the teaser: “You can save a lot of money by paying extra each month.”

Well, maybe, but that’s only one part of the picture. Many investment advisers, myself included, might argue that if you invested the extra money you were pumping into your mortgage, you could come out ahead.

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With mortgage interest rates as low as they’ve been, it’s likely that your investments could out-earn the interest you’d be paying.

In addition, there’s inflation to consider. Unless you have an adjustable rate mortgage (ARM), mortgage payments are fixed, meaning they remain constant. Thus, when adjusted for inflation, they become progressively smaller over time. Unfortunately, the message of “pay extra and save” fails to consider the Time Value of Money.

Is it ever OK to pay off a mortgage early?

Yes! There are some valid reasons why someone might want to pay off their mortgage early.

Income issues. If you expect your retirement income will be less than your earning years, then timing the completion of house payments for retirement may make sense.
Peace of mind. There are people who simply do not like having a house payment loom over their heads. This would be particularly true for someone in an uncertain job situation. Having no mortgage payment protects the home from foreclosure if employment is suddenly terminated and prospects of finding a new job are low.
Medical issues. A person who has a developing or worsening chronic illness may find getting out from under a mortgage before the disease worsens to a point of being very expensive is a big financial advantage and in line with good planning.
You have an adjustable rate mortgage (ARM). Less common now than a decade ago, these lending devices are structured to provide a low monthly payment in the initial years and rises later when (presumably) you earn more and can afford more – at least that’s the “official” theory. However, it was ARMs that contributed to the mortgage default bubble in 2007. If you have one, paying it off sooner than later is a good idea, as interest rates are on the rise these days.

Are There Other Ways to Reduce a Mortgage Payment?

Yes. Rather than paying your mortgage off early, you may want to consider refinancing, although as interest rates rise, the value of this option may be vanishing.

The decision to pay off a mortgage ahead of schedule is something to discuss with an independent financial planner. While there are times when paying off a mortgage early can make sense don’t buy into the canned line “you’ll save so much,” because in some ways, it simply may not be true.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Michael Tove, Ph.D., CEP, RFC, is a Certified Estate Planner and Registered Financial Consultant and founder of AIN Services, an independent multifaceted financial, estate and retirement planning agency located in Cary, North Carolina.