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A mortgage is a big debt, and your monthly loan payment could be one of the biggest bills you have to pay. For this reason, you might be tempted to try to pay off your home loan sooner, perhaps by making additional lump sum payments when you receive the money, or by making additional payments each month while you are working on the repayment. of the loan.
But before you go ahead and send more than the minimum to your mortgage lender, you should give some serious thought to whether mortgage prepayment is a smart financial decision. In fact, for most people, it’s best not to pay off your loan sooner than expected. Here are four big reasons why.
1. Mortgage interest rates are low
A mortgage is one of the cheapest types of debt around. It is very common to be able to qualify for a loan at a rate of around 3% or less, especially since mortgage rates have fallen during the COVID-19 pandemic.
Since the rates are so low, spending extra money on prepaying your loan offers a very low return on investment (ROI). You could do a lot better financially by focusing on paying off higher-interest debt first, such as credit card debt, personal loans, or even car loans.
Even after your debt is paid off, additional mortgage payments would still provide a low return on your investment. You could make safe investments, like buying an S&P index fund, instead of paying extra for your home loan. This could provide an average annual return on investment of around 10%, which is much higher than the return on prepayment of the loan.
2. You will tie up your money
Once you’ve made additional mortgage payments, it’s difficult and expensive to get the money you sent back to your mortgage lender. You will either have to sell your home or refinance your mortgage, which can lead to expensive and time consuming closing costs.
Instead of paying extra on your home loan and putting so much money into an illiquid investment, you might be better off paying only the minimum and putting extra money into an emergency fund or a more liquid investment that you can easily sell if you need to.
3. You will lose your mortgage interest deduction
If you itemize on your tax return, you can claim a deduction for mortgage interest. This means that your home loan becomes even cheaper. If you qualify for a $ 2,000 deduction and are in the 22% tax bracket, you could save up to $ 440 on your taxes. If you pay off your mortgage early, you will forfeit this government grant sooner.
4. Your mortgage gets cheaper over time due to inflation
Inflation reduces the value of your money over time. For example, $ 1,000 today might only have $ 970 in purchasing power a year from now if the inflation rate is 3%. But if you have a fixed rate mortgage, your payment never changes, which means it actually gets cheaper over time since you pay off your loan with money that isn’t worth as much.
Since paying off your loan gets cheaper every year, especially during times of high inflation, prepaying just might not make financial sense. This is even more true when you consider the loss of interest deduction, the loss of flexibility and the lost opportunity costs to invest your money in investments with a better return on your investment.
For all of these reasons, you might want to think twice before sending extra money to your mortgage lender.
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