Like many financial planning questions, no clear-cut answer exists to whether or not you should pay off your mortgage early. Rather, there are advantages and disadvantages to both paths. And, depending on your unique personal circumstances, you’ll have to determine what makes the most sense. As such, we’ll use this article to help answer the question: should you pay off your mortgage early?

Specifically, we’ll discuss the following:

• Advantages to Paying Off Your Mortgage Early
• Disadvantages to Paying Off Your Mortgage Early
• Wealth Building vs Stability
• Curtail and Refinance Your Mortgage: A Compromise
• Final Thoughts

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{Sponsored} The VA Home Loan offers $0 Down with no PMI. Find out if you’re eligible for this powerful home buying benefit. Prequalify today!

Advantages to Paying Off Your Mortgage Early

Advantage 1: Save on Total Interest Payments

One of the central reasons for paying off your mortgage early involves total interest payments. When you borrow money, you need to pay interest for the privilege of using those funds. And, on a 30-year mortgage, those interest payments can add up to tens of thousands of dollars (or more).

For example, assume you have 20 years remaining on what began as a $250,000, 30-year mortgage at 3.5%. If you make each payment on time for the entire 20 years, you’ll pay a total of just under $76,000 in interest during that period. Accordingly, if you have enough cash to pay off your mortgage early, you’ll save that $76,000.

Advantage 2: Improve Monthly Cash Flow 

Additionally, when you pay off your mortgage, you improve your monthly cash flow. For example, assume you have a 30-year, 3.5% mortgage with an original balance of $250,000. The monthly principal and interest payment on that loan totals just under $1,130. If you pay that mortgage off early, you’ll now have an extra $1,130 in cash flow every month.

But, it’s important to note here that, while saving on your mortgage principal and interest, you’ll still need to make the payments related to escrow. That is, mortgage or not, you’ll still need to pay property taxes and homeowner’s insurance. 

Advantage 3: Better Return than Low-yield Savings Account

You can also look at paying off your mortgage early as a form of investment. If you have a 3.5% mortgage, you effectively earn that rate of return on every prepayment you make. That is, you earn 3.5% by not having to pay that amount in interest.

And, as historically low as mortgage rates currently are, the average savings account yield is even lower. For instance, say you have $250,000 sitting in a low-yield savings account. It’s highly likely that these funds are earning more than 1% for you. As such, if you instead use them to pay off your mortgage, you effectively earn a return of 3.5% on those funds – far superior to what any savings account will offer.

Advantage 4: Peace of Mind

This last advantage is less tangible than the above ones. When you have debt – especially hundreds of thousands of dollars in mortgage debt – it can weigh on your peace of mind. Accordingly, paying off a mortgage early can absolutely ease that debt-related stress. Particularly when people approach retirement, the peace of mind afforded by paying off your mortgage can prove the most compelling reason for doing so.  

Disadvantages to Paying Off Your Mortgage Early

Disadvantage 1: Opportunity Cost

The primary disadvantage to paying off your mortgage involves opportunity cost, that is, what you can’t do because you use your cash to pay off a loan. In financial planning terms, paying off a mortgage means you lose the growth potential for alternative investments.

For example, say you have $100,000 remaining on your 3.5% mortgage, and you have that same amount sitting in a bank account. Yes, by paying off your mortgage you reap the above benefits. But, you also lose out on the opportunity to invest that $100,000. From 1926 to the present, the S&P Index (originally 90 stocks and now 500) has generated annual returns approximating 10%. Consequently, by choosing to “invest” in a 3.5% return (i.e. paying off your mortgage) rather than putting that $100,000 in an S&P-tracking index fund, you potentially lose out on 6.5% in potential returns.

Now, it’s important to note that, with a mortgage, you’re guaranteed a return, whereas past stock performance does not guarantee future performance. But, from a historical perspective, given a long enough time horizon, stocks far outperform average 30-year mortgage rates.

Disadvantage 2: Lost Tax Benefits 

While not as compelling as the above opportunity cost argument, paying off your mortgage early also eliminates the associated tax benefits. With an outstanding mortgage, you can deduct the related interest payments. If it’s your primary residence, you can deduct this interest (up to $1 million in primary mortgage debt) via the Mortgage Interest Deduction. If it’s an investment property, you simply deduct the mortgage-related interest as a business expense on your Schedule E.

Regardless of how you deduct your interest payments, paying off your mortgage early eliminates those benefits.

Disadvantage 3: Lost Hedge Against Inflation

Lastly, long-term mortgages provide an outstanding hedge against inflation. When you secure a 30-year mortgage, you lock in the same principal and interest payments for that entire loan term (NOTE: your insurance and property tax escrow payments will increase, though). For instance, say your principal and interest totals $1,000. With inflation, currency devalues. In simple terms, that means $1 ten years from now is worth less than $1 today.

From a mortgage perspective, this means that the $1,000 you’re paying in principal and interest today will be less valuable in the future. Or, put differently, you’ll pay down your mortgage in the future with more inexpensive dollars than today. That same $1,000 will simply be worth less. As a result, paying off your mortgage early eliminates that long-term hedge against inflation. 

Wealth Building vs Stability

Countless personal considerations exist when deciding whether or not to pay off your mortgage early. But, broadly speaking, we can generalize that the decision comes down to two priorities. That is, do you prefer building long-term wealth, or do you want stability and peace of mind?

Let’s use the example of a 30-year, $200,000 mortgage at 3.5%. If you make all 30 years of payments on time, you’ll eventually pay a total of approximately $97,500 in interest. But, let’s now fast forward to the 15-year mark of this mortgage. By that time, you’ll have an outstanding balance of roughly $125,000. The question becomes, are you better off using $125,000 in cash to A) pay off that mortgage, or B) make other long-term investments?

If you pay off the mortgage, you save roughly $36,500 in interest payments over the remaining 15 years of the mortgage. Alternatively, let’s say you invest that $125,000 in an S&P-tracking index, averaging 6% per year (a conservative return over a 15-year period). In this situation, you’ll earn just over $68,000 – $31,500 more than you effectively earn by paying off your mortgage early. And, when you combine this growth with the tax-related savings from your mortgage interest deductions, the returns are even better.

But, as attractive as these hypothetical stock returns are, they are not guaranteed. Accordingly, for homeowners prioritizing stability and peace of mind, the guaranteed 3.5% return from paying off your mortgage may make more sense than the potential 6% (or greater) return from investing those funds in the stock market (or another investment opportunity).   

Curtail and Refinance Your Mortgage: A Compromise

Fortunately, the decision to pay off your mortgage early isn’t an all-or-nothing one. For instance, say you have $200,000 and 20 years remaining on a 3.5% mortgage. And, conveniently, you have $200,000 sitting in your bank account. Yes, you can use that money to pay off your entire mortgage.

But, alternatively, you could curtail – or pay down – a portion of your mortgage, refinance the lower balance, and invest the difference. In this example, you could use $100,000 to curtail the loan then refinance the remaining $100,000 balance into a shorter-term, lower-interest mortgage. In this fashion, you reduce your total interest payments while shortening the repayment period.

And, this compromise also frees up the remaining $100,000 for another investment (e.g. stocks, down payment on an investment property, capital to start a new business, etc.). So long as you can command higher returns than your initial mortgage, you’ll have the benefits of investment growth with these remaining funds. Yes, these investment returns won’t be guaranteed, but by compromising, you reap the benefits of A) paying off your mortgage, and B) investing the remaining funds in higher-return options.

Final Thoughts

As stated, it’s difficult to say with complete certainty whether or not you should pay off your mortgage early. Rather, you need to consider your own unique financial and life situation. However, paying off a mortgage early generally increases your peace of mind, whereas investing those funds elsewhere typically results in greater long-term wealth.

Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.

The VA home loan provides veterans an outstanding mortgage option. But, many people ask whether buying a home makes sense for them. More precisely, is buying a better option than renting a home? As such, we’ll use this article to outline the major pros and cons of owning vs renting a home.

Specifically, we’ll discuss the following:

• Pros of Owning a Home
• Cons of Owning a Home
• Pros of Renting a Home
• Cons of Renting a Home
• Final Thoughts

Veterans Can Buy a Home with $0 Down

{Sponsored} The VA Home Loan offers $0 Down with no PMI. Find out if you’re eligible for this powerful home buying benefit. Prequalify today!

Pros of Owning a Home

Pro 1: Build Long-term Wealth

The primary advantage to owning over renting involves long-term wealth. When you pour money into rent every month, none of those dollars build your net worth. But, when you own a home, you build long-term wealth in two ways.

First, through loan amortization – the process of gradually paying down your mortgage – you build wealth. For example, say you have a $200,000 mortgage on a home valued at $300,000. As you make your monthly mortgage payments, that $200,000 loan decreases. And, with each dollar your loan balance shrinks, your equity – or ownership – in your home increases. Assuming no change in value, when your loan balance decreases from $200,000 to $150,000, your equity increases from $100,000 to $150,000.

But, property values do increase. Even accounting for short-term fluctuations, property values tend to consistently increase over time. This leads to the second way owning a home builds long-term wealth: property appreciation. Simply put, the longer you own a home, the more valuable it will become. Yes, inflation will offset some of these gains, but, on average, property appreciation has historically outpaced inflation.

Pro 2: Access to Low-interest, Long-term Loans

In addition to the wealth-building benefits of owning a home, home ownership also comes with outstanding loan terms. With most credit (e.g. personal loans, auto loans, credit cards, etc.), borrowers face relatively high interest rates and short repayment periods. With 30-year mortgages, borrowers can access low-interest, long-term loans not available elsewhere. These loans allow you to finance the purchase of a home – typically people’s largest life-time purchase – with extremely affordable terms.

Pro 3: Tax Benefits

Owning a home also comes with major federal tax benefits. First, homeowners with outstanding mortgages can deduct a portion of their mortgage interest from their federal taxable income. Known as the Mortgage Interest Deduction, this benefit allows homeowners to deduct the interest on their first $1 million in mortgage debt when filing federal income taxes.

Additionally, homeowners receive a tremendous tax benefit when selling their home. Normally, when you sell an asset that has appreciated in value, you must pay a capital gains tax on that increase in value. But, when individuals sell their primary residences, they can exclude up to $250,000 in capital gains ($500,000 for married filing jointly) from their taxable income.

Pro 4: Stability  

While less tangible, homeownership also offers stability. When you own your home, you know exactly where you’re going to be living, and you know how much you’ll need to pay to live there. For individuals seeking roots in a particular area, owning a home simply offers more stability than renting.

Cons of Owning a Home

Con 1: Fixed Costs

But, owning a home isn’t without associated disadvantages. In particular, homeowners face the following fixed costs. If they don’t pay them, they run the risk of foreclosure or liens placed on their homes:

• Mortgage principal and interest
• Property taxes
• Homeowners insurance
• HOA fees (as required)
• Flood and earthquake insurance (as required)

Con 2: Maintenance costs

Additionally, homeownership comes with recurring maintenance costs. If the dishwasher breaks in a rental, you just call the landlord and it will be replaced. But, when you own a home, you’re responsible for paying for these maintenance costs. And, while fixing a broken dishwasher may not be a huge cost, replacing a roof or re-painting a home certainly can be. Over your entire tenure as a homeowner, these maintenance costs will likely add up to tens of thousands of dollars.

Con 3: Fluctuations in Property Values

When you own a home, you also must account for short-term fluctuations in property value. As stated, homes generally appreciate over time. But, in the short-term, values often drop – sometimes significantly (e.g. the Great Recession). If you need to sell or refinance your home during one of these dips, you can be forced to realize a major loss.

Con 4: Large Up-front Costs

Buying a home also comes with huge up-front costs. With most conventional mortgages, borrowers must have a down payment of at least 20%. On a $300,000 house, that means you’ll need a $60,000 down payment.

But, home loans also come with closing costs, which will increase your out-of-pocket costs on the front-end of owning a home. While these costs vary, they average 3% of the loan amount. With this $240,000 loan, that means you’re looking at $7,200 in closing costs, translating to $67,200 in total up-front costs.

Con 5: Lack of Flexibility

Owning a home also inherently limits your flexibility. When you rent, you can always choose to not renew a lease if you want to move. While you can sell a house if you decide to move, it requires far more time, effort, and administrative headaches than moving out of a rental. And, if you decide to sell during a market downturn, you will also likely lose money on the sale.

Pros of Renting a Home

Pro 1: Limited Maintenance Headaches

Many of the advantages to owning a home translate to associated disadvantages to renting – and vice versa. For instance, renting a home inherently limits the maintenance headaches – and costs – you’ll face. When you need to deal with a maintenance issue as a renter, you typically just call the landlord or property manager. You normally don’t have to coordinate with and pay for your own contractor.

Pro 2: Potentially Lower Monthly Costs

Renting a home can also – potentially – translate to lower monthly costs. A lot of this will depend on the local market, your lease agreement, and whether or not you need to pay for utilities and HOA fees. But, many tenants face lower monthly housing expenses than a comparable homeowner would. However, these lower expenses don’t account for the fact that renters do not build equity – and long-term wealth – in a leased unit.

Pro 3: Location Flexibility

Many people – especially young professionals – want to live in expensive, urban neighborhoods. Buying a home in many of these neighborhoods is prohibitively expensive. This means that, if someone wants the flexibility to live in certain neighborhoods, they’ll need to rent.

Pro 4: Limited Up-front Costs

Whereas buying a home requires tens of thousands of dollars in up-front costs, renting one typically doesn’t. Even with a security deposit requirement, people can rent a home for far less in up-front costs than buying a comparable property.

Cons of Renting a Home

Con 1: No Long-term Wealth Accumulation

Without a doubt, the largest disadvantage of renting a home is that your lease payments do not build long-term wealth. When you pay rent every month, none of those dollars contribute to your net worth.

However, you can potentially offset this disadvantage by properly analyzing the local housing market. Say, for instance, you can lease a home for $1,500/month, but owning a comparable home would cost you $2,000/month. If you invest this $500 difference every month, you can somewhat offset the fact that you aren’t building equity in your home.

Con 2: Rent Payments Don’t Improve Credit Score

For some people, poor credit scores prevent homeownership. That is, they simply don’t have good enough credit to be approved for a home mortgage. Unfortunately, renting doesn’t help this reality. Currently, the major credit bureaus don’t account for rent payments in credit score calculations. This means that homeowners who already qualify for loans can further improve their credit scores by making timely mortgage payments. But, if you rent, making timely rent payments does not help improve your credit score.

Con 3: Limited Control of Rental Rates

Unless you live in a rent-controlled property, there’s little you can do when your landlord hikes rents. Yes, you can negotiate renewal terms in an original lease. But, if you fail to do this, a landlord could very well decide to massively increase rents if you choose to renew. Of course, you can move in these situations. But, if you want to stay in a property, you inherently have limited control over rental rates as a tenant.

Con 4: Limited Ability to Personalize a Space

Lastly, many lease agreements have strict clauses regarding unit modifications. That is, if you want to paint, redo a kitchen, or make any other modification, you’ll need to seek landlord approval. And, if your landlord doesn’t want any changes made, this means you have limited ability to personalize an apartment or house as a renter.

Final Thoughts

No absolute answer exists to the rent vs own question. Rather, individuals need to assess their own unique situations and the above considerations to determine what makes the most sense. Generally speaking though, if you prioritize building long-term wealth, owning a home makes sense. Conversely, if you prioritize flexibility and lifestyle, renting may be a better option.

Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.

The VA home loan benefit is one of the most valuable for veterans; it provides the means for a qualifying borrower to explore home loan options without a down payment in typical cases, and for some borrowers there may be waivers for certain home loan fees.

VA loans feature the option to apply for a Streamline Refinance loan later on, using the original application information to qualify for the new loan. (See below)

These are just some of the reasons why it can be a smart idea to consider applying for a VA mortgage loan instead of a conventional loan or other non-VA options.

Some of the most attractive perks of the VA loan benefit are simply not available for conventional mortgages, and other government-backed loans may not offer the same types of advantages for some buyers-especially those who have VA disability ratings or are eligible to receive compensation for service-connected disabilities.

{Sponsored} Veterans Can Buy a Home with $0 Down
The VA Home Loan offers $0 Down with no PMI. Find out if you’re eligible for this powerful home buying benefit. Prequalify today!

VA Loans Are Used To Buy, Build, Or Refinance

You can use a VA mortgage to purchase, rehab, refinance, or build a single family home up to four units. These properties can be houses, condo units, town homes, co-ops, planned unit developments, and others. These loans are for owner-occupied residences and not for commercial properties or business enterprises.

No Down Payment Required For Most VA Loans

The no-money down option is a standard feature for VA mortgage loans. Borrowers are not required to make a down payment except under certain conditions related to creditworthiness or in cases where the appraisal is lower than the asking price.

Thanks to the VA loan “escape clause”, a borrower is not required to purchase a home in such cases, but those who choose to do so cannot finance the difference between the appraised value and the sales price.

Some Will Put Money Down Anyway

Some borrowers will choose to make a down payment on their VA home loan anyway as this can reduce the amount of your VA loan funding fee. In such cases, the down payment must be above a certain percentage to qualify for a discount on the fee–ask your loan officer how much you should realistically expect to pay in such cases based on the loan amount and the term of your mortgage.

VA Loans: No Private Mortgage Insurance Required

Private mortgage insurance, or PMI for short, is generally required by conventional lenders when a borrower does not make a high enough down payment. In general you may find conventional lenders requiring PMI when the loan-to-value ratio is 80% or higher.

That means in order to avoid PMI on a conventional loan you may be required to make a down payment totally 20% of the adjusted value of the home (or more). Credit scores can also be a factor, depending on circumstances.

The FHA single family loan program, another government-backed loan similar in many ways to VA mortgages, does not require private mortgage insurance, but does require an up front mortgage insurance premium and an annual premium paid over either the lifetime of the loan or for 11 years, depending on factors including (but not limited to) the loan-to-value ratio, and the duration of the loan.

Remember, this type of mortgage insurance protects the lender and is not the same thing as home owners insurance to protect your property from theft, fire, etc.

VA Loan Funding Fees

Remember, this type of mortgage insurance protects the lender and is not the same thing as home owners insurance to protect your property from theft, fire, etc.

It’s true that VA home loans do include a VA loan funding fee, which is affected by the amount of down payment you choose to pay (if any), and whether you are a first time buyer or have used your VA home loan benefits before. The people who qualify for the lowest VA loan funding fee are first-time buyers who choose to put 10% down on the loan.

The people who qualify for the lowest VA loan funding fee are first-time buyers who choose to put 10% down on the loan.

The VA loan funding fee is waived for all service members receiving or eligible to receive VA compensation for service-connected medical conditions or injuries. This requires the VA to have completed its process for determining the percentage of disability and awarding that amount to the veteran officially.

These waivers are NOT automatic and must be applied for. Those who wish to apply will be required to furnish a completed copy of VA Form 26-8937 which shows the exempt status of the borrower. Here’s a sample copy of VA Form 26-8937.

The VA loan funding fee waiver also applies to certain Purple Heart recipients who are still on active duty who furnish proof of the award before loan closing time.

In cases where a funding fee refund might be due at a later date, the lender will have the borrower make the payment and apply for the refund once the official VA notification of a disability award is obtained.

Refinancing From Non-VA Loans To VA Mortgages

VA loans are not just for new purchases-if a borrower has a non-VA mortgage and wants to refinance into a VA mortgage loan, this option is available for financially qualified borrowers. Those who wish to refinance from non-VA to VA mortgages will need to find a participating VA lender willing to perform the transaction.

VA loans can be refinanced into lower mortgage payments and/or interest rates with a VA Interest Rate Reduction Refinance Loan, also known as the VA IRRRL. Ask a participating VA lender about the VA-to-VA IRRRL option.

VA Refinance Loan Options

VA loans are similar to FHA mortgages in one important respect–both of these government-backed mortgage loan programs offer the borrower the ability to apply for a Streamline Refinance loan, which is sometimes referred to as an Interest Rate Reduction Refinance Loan or IRRRL.

These loans typically must result in a tangible benefit to the borrower. This can be in the form of a lower interest rate, a lower monthly payment, and can also be used to get out of an adjustable rate mortgage into a more stable and predictable fixed-rate loan.

These loans are unique as they have no VA required credit check or appraisal. If your lender does not require one anyway, this is a good opportunity to refinance without having to go through an extensive application process similar to the original mortgage.

Yes, you’ll still need to complete paperwork and work with the lender, but there are good reasons to consider this as a benefit to having your original VA loan.

VA mortgages are also assumable, which means that you (with the lender’s approval) can transfer your VA loan to another person and have them assume financial responsibility for the mortgage.

Another perk of VA mortgages is that they typically feature lower interest rates than conventional loans due to the government’s backing of the loan. But your credit scores and the current going rate will be important factors in the rate you negotiate with the lender. Keep that in mind when you are in the planning and saving stages of your home loan.

Joe Wallace is a 13-year veteran of the United States Air Force and a former reporter for Air Force Television News.