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When to Pay Off a Mortgage Early

Brian O'Connell

If you can afford to pay off your home mortgage early, good for you – it’s usually a great financial move. But not always.

If you have other big debt items (like credit cards) or you plan on moving in the next few years, paying your mortgage early may be a bad move. To know what factors influence that decision, the folks at Freedom Debt Relief came up with a couple of questions to ask to help you decide if you should pay your home mortgage off early.

“With consumer revolving debt balances declining nationwide and home values flat, some homeowners are considering paying off their mortgages early,” says Kevin Gallegos, vice president at the San Mateo, Calif.-based company. “For people who are staying put in their home for some time, paying a mortgage off before the end of its term has benefits. Obviously, making extra payments eliminates the loan debt faster. This in turn dramatically lowers the total interest paid over the life of the mortgage.”

A March 2006 study from the Federal Reserve concluded that 16% of U.S. homeowners prepaid their mortgages annually (and that was before the Great Recession). But mortgage debt is one of the most affordable debts around, as far as interest rates go, with most charging interest rates around 5%, much lower than the interest you pay on credit card debt.

To find out if your situation merits early repayment, ask yourself these key questions:

Would early repayment sacrifice your long-term financial future or your short-term financial health? While prepaying your mortgage has great advantages, should you do it at the expense of other debt and your long-term savings?

“It’s most important, in that situation, to be sure you will have enough cash to fund your retirement,” said Gallegos. He says consumers should ask themselves if they can afford to pay more each month and if they have an emergency fund that could cover six months’ living expenses? If the answer is “no” then it’s best to keep paying regular mortgage payments until the answer to those two questions is “yes”.

Do you plan on moving soon?

If you’re planning on moving, you’ll need plenty of cash for a good down payment. The days of slapping down 5% or even 10% for a home mortgage down payment are going the way of the dodo bird. “The market is still a bit wobbly in most locales,” Gallegos says, “and lenders are demanding higher down payments than in recent years. If you plan to relocate soon, hang on to your cash for the move.”

Does your mortgage carry prepayment penalties?

Not all mortgages have prepayment penalties, but those that do can unload a financial sledgehammer that you may not see coming. To be sure, read your home loan’s “truth in lending” disclosure and see if yours has a pre-payment penalty and how much it will cost you.

If you decide to prepay, make sure you do so early in the life of your mortgage – that’s when it does the most good in reducing long-term interest. And ask a financial advisor for help in figuring out whether you’re better off pre-paying a mortgage or putting that money to work for you and your retirement fund.

You may want to fully own your home, but you don’t want to lose your shirt in the process.