When mortgage rates were forced artificially low during the COVID period, I had to have serious conversations with clients on if they should pull extra cash out with a refinance if they’ll have an economic need for that money in the future. This was because they weren’t going to be awarded that low rate when they’ll want it. I also have clients that made it a habit of applying extra money towards their monthly payment to pay off the mortgage early. We have to discuss if that’s just a habit, and does it make economic sense, or an emotional need to be debt/mortgage free?
The decision to pay off your mortgage early is complex and depends on a variety of financial and personal factors. This decision becomes even more nuanced given the unique circumstances many homeowners find themselves in due to the artificially low mortgage interest rates during the COVID-19 pandemic. Many property owners locked in historically low rates around 3%, creating a unique financial landscape. Here are a few thoughts to help you determine if and when you should consider paying off your mortgage early. I’m also always available to bounce ideas and numbers off of, if you want an independent observation.
Understanding Your Mortgage Rate
First, let’s address the significance of having a mortgage rate around 3%. Historically, this rate is incredibly low. Typically, mortgage rates fluctuate between 4% and 7%, with higher rates seen during inflationary periods. If you’re sitting on a 3% mortgage, you have access to cheap capital. This can significantly impact your decision-making process.
Benefits of Keeping a Low-Interest Mortgage
With a low mortgage rate, your money might be better invested elsewhere. The stock market, for instance, has historically returned an average of 7-10% per year. By keeping your mortgage and investing your extra cash, you could potentially see higher returns. Additionally, maintaining liquidity is crucial, especially in uncertain economic times. By not tying up your money in paying off your mortgage, you keep cash available for emergencies or other investment opportunities. I see many property owners’ equity rich, cash poor. Mortgage interest is often tax-deductible. Although recent tax law changes have limited these deductions for some homeowners, it’s still a benefit worth considering.
When to Consider Paying Off Your Mortgage
As you approach retirement, reducing your monthly expenses can provide “peace of mind”. Paying off your mortgage can free up income for other retirement needs and reduce your financial obligations. If you have high-interest debt, such as credit card balances or personal loans, it generally make more sense to pay those off first. However, if those are under control, paying off your mortgage could be a good next step. For some, the emotional benefit of owning their home outright outweighs potential financial gains from investments. If the idea of being debt-free helps you sleep better at night, that’s a valid reason to pay off your mortgage. If you prefer guaranteed returns and less risk, paying off your mortgage can be seen as a risk-free investment with a guaranteed return equal to your mortgage interest rate (e.g., 3%).
Factors to Consider
Ensure you have a robust emergency fund before paying off your mortgage. Financial flexibility is important, and an emergency fund provides a safety net. Evaluate your other investments. If your investment portfolio is well-diversified and performing well, it might not make sense to shift your strategy. Consider your overall financial health, including retirement savings, college funds for children, and other long-term financial goals. Make sure these are on track before allocating extra funds to your mortgage. Keep an eye on current and projected market conditions. If interest rates are expected to rise, your low-rate mortgage becomes even more valuable.
Practical Steps
Use financial calculators to compare the benefits of paying off your mortgage versus investing the money. Consider both short-term and long-term scenarios. A financial advisor and or I can provide personalized advice based on your specific financial situation, helping you weigh the pros and cons effectively. If you’re not ready to pay off your mortgage entirely, you can consider making extra payments toward the principal. This reduces the overall interest you pay over the life of the loan, but if you have a fixed rate mortgage your monthly payment will not change. Only the amortization timeframe and when the mortgage will be paid off. Ensure that paying off your mortgage aligns with your broader financial goals. It shouldn’t come at the expense of other critical financial objectives.
More Variables to Consider
Going the other direction, when equity rich but have other obligations that require a large cash outlay like home improvements or renovation, debt consolidation, education expenses, a refinance or home equity line may make economic sense. Even if the interest rate on a refinance may be higher that the present rate, the blended rate and monthly payment may be more logical than sticking with the present mortgage low rate.
Their may be a point where age, income level, and living expenses require a valid look at a Reverse Mortgage. This would allow the conversion of home equity into cash without monthly payments, repaid when the homeowner sells the home, moves out, or passes away. These are good programs for certain applications. I’ve been originating them for years, and feel
I’ve been originating Reverse, conforming and Non-Conforming mortgages for many decades. Call me to crunch numbers and evaluate options.
Deciding whether to pay off your mortgage early is a deeply personal decision that depends on various factors, including your financial situation, investment opportunities, risk tolerance, and personal preferences. For those with a 3% mortgage rate, the decision is particularly challenging given the low cost of borrowing. Balancing the potential benefits of keeping a low-interest mortgage with the desire for financial freedom and security is key. By carefully considering your options you can make the choice that best fits your unique circumstances and long-term financial goals.
If you are in the Los Angeles area, and have any questions or real estate sales or financing needs, feel free to contact me
Ron Henderson GRI, SRES, SFR, RECS, CIAS, CREN, GREEN
President/Broker
Multi Real Estate Services, Inc.
Gov’t Affairs Chair – California Association of Mortgage Professionals (2017-2018)
Chairman – OutWest Marketing Meeting (Real Estate Education)
BRE #00905793 NMLS #310358
www.mres.com
ronh@mres.com
Specialist in the Art of Real Estate Sales and Finance
Real Estate market, mortgage rates, Los Angeles, San Fernando Valley, Conejo Valley, Simi Valley, Woodland Hills, West Hills, Calabasas, Chatsworth
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