First Person: The Pros and Cons of Paying Off a Mortgage Early

If you own a home, you may be lucky enough to have some extra cash available for investment. Of course, purchasing stocks, bonds, or other equities is always a good idea; however, it is disheartening to see your stocks drop 5% or more in a single day. On the other hand, receiving your mortgage notice, and realizing that only a small fraction of your money is going toward the principal is equally disheartening. The dilemma that you might be facing is: should you pay off your mortgage early or invest the extra capital elsewhere?

To answer that question, here are four advantages to paying off your mortgage early:

No more mortgage interest. Many individuals justify their excessive mortgage interest with the fact that it is tax-deductible. However, money paid is still money lost, regardless of whether the IRS deducts it from your earnings or not. On the other hand, if that money does not go toward paying mortgage interest, you will get taxed on it, but at least you will be keeping the remaining portion of that money for other needs.

Freedom to buy another house. If you decide you want to move out of your current house, you will have trouble buying another house because that will require that you pay two mortgages until your current house is sold. Many home buyers even make the purchase of their next home contingent on the sale of the prior one, reducing their chances of getting the house they want outright.

Worry-free retirement. With many people taking 30-, 40-, or even 50-year mortgages, it is a sure bet that they will be making mortgage payments long after retirement. However, retirement often comes with added health problems and a reduced income. The mortgage that you could afford in your 40's and 50's may not be so affordable now that you're in your 60's, retired, and saddled with medical bills.

Fewer job loss worries. If you lose your job, you might find part-time work that allows you to pay your bills and groceries. However, paying your mortgage month-to-month will be difficult on a reduced income. You could end up in debt before you find your next job, or you might even need to foreclose.

However, there are also some disadvantages to paying off your mortgage early.

Being "house-poor." If you put all your extra money into your house, you will certainly pay it off early, but at the cost of being "house-poor". If any financial emergency comes up, you will have limited means to cash, unless you spend yet more money to obtain a home equity loan.

Cinching on retirement investments. Many people cinch on their retirement account contributions while trying to pay off their mortgages early, assuming they'll make up for those neglected contributions later. However, nothing makes up for lost time, when an IRA or 401(k) could have been earning the S&P 500 average of 11% a year. Even large IRA contributions in later years do not make up for that lost time, because money that is earning interest today also earns compounded interest (i.e., interest on the interest earned).

Missing out on stock dividends and gains. Not all stocks drop in price, and even when they do, they usually make a recovery. Many stocks not only appreciate, but they pay a handsome dividend. In many cases, it is very easy to make a good 20% or more on stock gains and dividends.

Lower returns. Paying off a mortgage early made sense when mortgage interest rates were 8% or higher; however, some homeowners pay 4% or even less on their current mortgages. By comparison, credit card interest rates are often 25%, car loan rates are around 6%, and payday loan interest rates can be an incredible 80%! It is far better to worry about (and pay off) the high interest loans rather than a loan that is currently at a historically low interest rate.