Paying Ahead on Your Mortgage May Not Be a Good Idea Right Now

• Author: Michael Bordonada
• Posted: 2024-05-12

Many personal finance experts advise you to make extra mortgage payments to get ahead on this debt. However, this conventional wisdom is not always correct. In fact, unless you need a place to shelter your money to ride out the storm, this may not be the best time to make extra mortgage payments. While this may save you money on the amount that you pay for your home, there are better ways to use the money right now. Here are some reasons why you should not listen to the experts who are currently telling you to pay more towards your mortgage each month.

The Savings Occurs Years into the Future

First, it is important to know how making extra payments can save you money. Getting ahead on your mortgage does not necessarily lower your monthly payments today. They may buy you an extra grace period if you cannot make a payment, but the primary savings comes in the future. Paying ahead means that you are done paying off your mortgage earlier. If you have a 30-year mortgage, it could be decades until you reap the benefits of this.

However, if you are like many Americans, you have been able to take advantage of rock bottom interest rates to refinance your mortgage. Some have reported getting refinancing rates as low as 3%. This means that it does not cost you very much to borrow money for your home.

Then, you must factor in the tax deduction for mortgage interest that you pay. This further reduces the cost of your interest by your marginal tax rates. Once you factor in your tax savings, your cost of mortgage capital can fall below 3%.

You Can Invest the Money and Earn More

Of course, interest rates in general throughout the economy have fallen. Therefore, you would not be able to simply put the extra money into a savings account and get a higher rate of interest. However, if your investment strategy would pay you more than 5% on average, it may be a better use of the money to simply invest it right now.

Instead of paying more towards your mortgage, the better course of action would be to increase your retirement contributions right now. Not only are these tax-advantaged, but the drop in asset prices makes for attractive entry points into these securities. In other words, paying ahead just for the sake of saving a little bit on your mortgage is not worth the opportunity cost of capital. In other words, the money that you pay towards your mortgage could be earning you more elsewhere. Mortgages are so cheap these days that some debt is just worth it to have when it costs you so little. Factoring in tax benefits and the rate of inflation, mortgages are almost free right now.

Consider Keeping the Money in an Emergency Savings Account

Even if you do not want to invest right now and try to earn additional returns, your money may be better put to use as part of an emergency savings fund. Unemployment is still in double digits and people who have kept their jobs are still not out of the water as far as the risk of losing a job is concerned. Paying ahead on your mortgage is a way of saving money, but it commits your extra money to one creditor. Once you pay in the extra money, the only way to get it out is by not making your next mortgage payment.

Given the minimal amount of money that you would save, it may not be worth it when it reduces your financial flexibility. It may be more worth it to you to have access to the money now as opposed to saving money years in the future.

Moreover, paying off your mortgage early right now could be a risk given the fact that home prices have yet to fall from the COVID-19 pandemic. Making early mortgage payments is essentially the same thing as investing in the real estate market. If you were to sell your home, you are not assured of getting your money back, especially if the price of the home falls. This would just become part of the payment to the bank if you ended up upside down on your mortgage. Thus, you may want to be careful about putting anything extra into your home right now until the COVID-19 crisis subsides.