More than half of Americans own their homes rather than rent, and if you're one of them, you're probably used to getting a mortgage statement in the mail each month. Now if you take a close at that statement before writing out your check, you'll notice that a chunk of what you're paying is applied to the interest portion of your loan, as opposed to its principal. This especially holds true if you're in the early stages of your mortgage. And if the idea of paying all that interest doesn't sit well with you, you may be inclined to pay off your mortgage early, which will reduce the amount of interest you pay in your lifetime.
It's a smart idea in theory. But here's why you're better off holding onto your mortgage and not accelerating your payments.
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You'll have less money available to invest
If you signed a mortgage over the past decade or so and had good credit at the time, chances are you snagged a pretty decent interest rate on it. If that's the case, then it pays to hang onto your available cash rather than pump it into a low-cost home loan. That's because you'll then have the option to invest that money, and at a higher return than what your mortgage is charging.
Imagine you're 10 years into paying a $200,000, 30-year fixed loan at 4% interest, and that you have the ability to take a lump sum of $20,000 and apply it to your mortgage. Doing so will save you roughly $21,000 in interest over the life of your loan. But if you were to take that $20,000 and put it into the stock market instead, in 20 years from now, you'd be sitting on over $77,000, assuming a 7% average annual return (which is below the market's average).
In other words, using your free cash to invest rather than pay down your loan gives you more than $50,000 extra in this scenario. Of course, the extent to which you'll come out ahead by going this route will depend on the specific numbers you're dealing with, but the point here is that if you have a home loan with a favorable interest rate, it doesn't always pay to knock it out sooner.
You'll lose out on a valuable tax break later in life
As you progress in your career, you'll ideally start earning more money. And while that's a good thing from a cash flow perspective, it could spell trouble from a tax perspective. That's why it's crucial to keep your tax-saving options open later in life, when your earnings reach their peak. But if you pay off your mortgage ahead of schedule and lose out on the mortgage interest deduction down the line, you could end up suffering from a tax perspective.
Currently, you're allowed to deduct your mortgage interest in full on new loans of up to $750,000. However, if you signed your mortgage before 2018, that limit stands at $1 million. If you pay off your mortgage ahead of schedule and lose the interest deduction, your tax bill might go up at the worst possible time.
Of course, hanging onto a mortgage isn't the right move for everyone. As colleague and personal-finance expert Dan Caplinger points out, it sometimes pays to get rid of a home loan early if you have the ability to do so.
Just remember that carrying a mortgage can be helpful from a tax perspective, and that having more cash on your hands opens the door to different investment opportunities that could be far more lucrative than the savings you'll glean from reducing your lifetime interest costs. Furthermore, you never know when you might need money to pay for a host of expenses, from college to major car repairs. Keeping your money out of your mortgage and in your bank account buys you more options, and that itself is a reason to stick to your regular payment schedule.
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