Should You Prepay Your Mortgage?

I know the investment gurus say don't do it, but let's look at the pros and cons.

First the Cons

Once your mortgage is paid off, you will have lost your biggest tax deduction. This may not be true for people who purchased their homes prior to the last real estate boom. I'll use myself as an example. I bought my house just before prices went through the roof. I've never deducted my mortgage interest because the standard deduction has always been higher. I can take the standard deduction whether I keep my mortgage or retire it so I have nothing to gain by continuing to pay mortgage interest.

Folks who bought their homes in the past five years most likely do deduct their mortgage interest. Let's do the math. If you paid $12,000 in mortgage interest last year, by deducting it you stand to recoup about 30% of that amount (depending on your tax bracket) or $3,600. You're still out $8,400. If you retire the mortgage, the entire twelve grand stays in your pocket.

Mortgage interest rates are low. If you have extra money, you should invest it in something with a higher rate of return than your mortgage. I do have money in investments that usually pay a higher rate of return than the interest rate I'm paying on my mortgage. True, I could just put the money I'm planning to use to prepay the mortgage into those. I don't think I want to do that because these investments are somewhat risky. In fact, I don't know of any safe investment that earns more than about 5%. Residential real estate is one of the safest things you can put your money into.

A house is not a liquid investment. If you should need the money in the future, you would not be able to get at it easily or quickly. You would have to either borrow against your equity or sell the property in order to get your money back out of it. This, to me, is the most valid argument against prepaying your mortgage. The interest rates on home equity loans are substantial; you would hate to have to pay this just to borrow your own money. You also probably would not like to have to sell your home in order to deal with a financial emergency. There is a solution. Don't even think about prepaying your mortgage until you've got 4-6 months of living expenses socked away in a safe place. Also, don't devote all your discretionary income to paying down the mortgage. Put a portion of it into savings instead.

Now for the Pros

Retiring your mortgage early will do wonders for your budget. The average homeowner's biggest monthly expense is their house note. It's the biggest bill at my house-- yours too, I'll bet. Just think of all the things you could do with that money if you didn't have to send it off to your mortgage lender every 30 days. You could take better vacations. You could remodel the kitchen. You could make bigger contributions to your retirement account. Although, ironically, not having a mortgage to pay means you would need less income in retirement.

Any money invested in prepaying your mortgage will earn you a guaranteed rate of return. In a world where few things are certain, this is valuable. Even if you are fortunate enough to have locked in a low interest rate on your loan, a guaranteed 5.5% or 6% return on a safe investment is not a bad deal. The higher your interest rate, the more you stand to gain by prepaying your mortgage.

After looking at the pros and cons, I decided to ignore the financial experts and prepay my mortgage. I think that, for someone like me, the benefits far outweigh the disadvantages.