People love love LOVE paying off their mortgages early. I understand the emotional appeal. I know the appeal of less interest paid out over a couple of decades. I see people who are delighted to have paid their mortgage in 10 or 12 years instead of 15 or 30. But I still often advise clients against doing it. Here are five reasons why:
1. The bank is not your friend. If you prepay, you’re not going to get a card with a happy face on it. And if you send in extra money for several months and then find yourself in a unexpected cash bind and are unable to make your normal payment for a couple of months, you’ll be wearing a frownie face as you read the threatening letters from your lender.
2. The math is not your friend. When you send in an additional payment, that payment is applied against the principal on your loan. Most typically, that will come off the back end of the loan—and the back end is where the smallest monthly interest payments are. So you probably won’t be saving as much interest as you think.
3. The uncertain future is not your friend. You may have a loan right now at 4% or 5% interest. If you pay it off and then find yourself needing to access all that lovely equity in your home, you may well have to take on a higher interest rate. While all interest rates are currently at near-historic lows, home equity lines have often averaged one or two percentage points higher than conventional fixed-rate loans.
4. The tax laws are not your friend. You can deduct the mortgage interest on up to $1 million in total purchase debt on a first and second home. But you can deduct interest on only $100,000 of home equity line debt, plus additional interest on certain home improvements and other qualified costs. Pay off that big mortgage early and you’re restricting your access to future tax-deductible home mortgage interest. (For oodles more on what interest is deductible and what isn’t, courtesy of the IRS, go here.
5. Did I mention the bank is not your friend? I recently saw a client who had paid off the loan on her $300,000 home and wanted to get a $100,000 line of credit against it. The bank that’d made the original loan wasn’t interested in her business. The reason: she couldn’t show the ability to repay the loan based on her current income. The bank cared only about the income of the borrower, not about what the home might be worth. When you prepay a loan, you take easily accessible liquid funds and move them into hard-to-access property assets.