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Should you prepay your mortgage? Pros and Cons

Should you prepay your mortgage? Pros and Cons

Should you pay your mortgage in advance? For some homeowners, it is a wise financial decision, but for others, it makes no sense to increase your payments. To determine if prepayment is right for you, here are the pros and cons mentioned by financial experts.


PROS 

This Will Reduce The Interest You Owe

Interest is the extra commission you pay the lender for lending you the money to buy a home. After all, lenders not only distribute money for free but also make money.

By increasing monthly payments, called prepaying your mortgage, you will save money on interest. These savings can increase dramatically.

For example, suppose you get a $ 200,000 mortgage with a fixed interest rate of 4% and a term of 30 years. If you continue to make the minimum monthly payments, you will pay more than $ 143,739 in interest for 30 years until the debt is paid off. But if you still pay $100 extra monthly, you would only pay $116,702 in interest over 25 years, saving$ 27,037.


You Will Get Your Credit In Advance

By accelerating mortgage payments, you will also reduce the time required to pay off the loan, increasing your cash flow. This is an excellent incentive for some borrowers.

For families with young children, where parents are anxious to pay their children's school fees, we sometimes recommend increasing the mortgage payment, so that when your children go to college, their mortgage obligations. 

Paying more money each month for mortgage capital can also give you peace of mind. Emotionally, it's good to know that you're paying off your mortgage sooner than you expected.


You Will Quickly Increase Your Equity

No matter how much you deposit on your mortgage, the equity in your home is the current value of your home minus the amount you owe on your loan. Let's say your home is worth $300,000, and your mortgage balance is $ 240,000. If yes, you would have $ 60,000 or 20% of the accumulated value of the house.

Making larger mortgage payments than a credit will allow you to build up capital faster. Having more equity in the home can be a great blessing if you want to get a loan or line of credit to pay for improvements to your home


Helps Credit Score 

Demonstrating less debt and managing your debt responsibly by paying off your mortgage earlier can increase your credit score. This can help if you are planning to apply for a car loan or second mortgage for a vacation home, as your credit score would affect the interest rate for which you qualify.


CONS


Prepayment reduces interest on tax-deductible mortgages

Since the down mortgage payment reduces interest, it may not make sense in terms of tax savings. Mortgages are structured to pay more interest than the principal.

For example, in the first year of a $300,000 30-year loan with a fixed interest rate of 4%, you will deduct $10,920. 

However, the mortgage interest deduction under the new tax law requires itemized deductions, and the breakdown may not make sense for many homeowners, as the standard deduction has gone under the new tax plan to $ 12,200 for individuals, $ 18,350 for heads of families and $ 24,400 for couples with common income.

Another thing to remember: in the past, it was possible to deduct interest of up to $ 1 million on the mortgage debt (or $ 500,000 if there was an individual return). However, for loans starting on December 15, 2017, only interest on the first $ 750,000 of mortgage debt is deductible.


You may miss more profitable investment opportunities

Every dollar you invest in your main mortgage is a dollar that you cannot invest in high yield companies, such as stocks, high yield bonds, or real estate investment funds.

That being said, you risk investing more money, let's say, in the stock market than investing in your mortgage. You have to consider risk tolerance before deciding where to put the extra money.


You Can Lose Your Debt Payments At Higher Interest Rates

For many homeowners, paying higher interest debt, such as a credit card or private student loan, is more important than paying the mortgage upfront.

Think about it: if you have a monthly credit card debt of $ 400, with an interest rate of 20%, the amount you pay on your credit card is $80 per month, which means it would be an advance. Higher than what you would pay in a mortgage with an interest rate of 4%.


Prepaying a mortgage can make it difficult to achieve other financial goals

Of course, growing retirement savings is essential. However, some people mistake paying their mortgages in advance, instead of maximizing their retirement contributions.

Before focusing on prepaying mortgages, people should create a sufficient emergency fund, usually one large enough to cover important expenses for three to six months.


There may be fines for prepaying the mortgage

Some lenders charge a fee if a customer's mortgage is paid off in full before the end of the loan term. This is why it is essential to check with your mortgage lender or search for the term "prepayment disclosure" in the mortgage agreement to see if there is a penalty and, if so, how much.

If you do not have enough money to pay off your savings before you start paying off your mortgage in advance, prepaying the loan can put you in a difficult financial situation in an emergency.


Final thoughts

Buying a home is essential because, frankly, no one wants to pay rent for the rest of their lives. However, you need to find an appropriate lender that offers the best mortgage rates available. Prepaying the mortgage helps you eliminate the debt burden in advance, but there are some considerations to keep in mind.

We discuss the pros and cons of paying the mortgage advance. We also share the mistakes to avoid when taking out a mortgage. The most vital thing is to understand the structure of the mortgage. You should not tie up your money because you can use it for other purposes, such as paying off debts at high-interest rates. You should also save on retirement and reserve something in your emergency fund. Before committing to financial obligations, you need to speak to a financial expert to guide you through this process.

Still not sure where to go? Consider consulting a financial planner to discuss your finance options.



Unifirst Financial & Tax Consultant
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