What to Know About Paying Off Your Mortgage Early

Getting out of debt is a major goal for many, but savvy homeowners should do their homework before making major financial decisions, including paying off a mortgage. Creating a sound financial future includes developing a household budget, planning for retirement even though retirement might be decades away, and making sure you’re adequately insured against property damage or an untimely death that could leave your family strapped for funds. Those who fail to plan may have to work later into life or may struggle financially during retirement. It’s never too soon (or too late) to look out for your financial future.

For many homeowners, their mortgage payment represents the single largest check they write every month, so once the house is paid off, naturally they’ll have more money available for other expenses. If you’ve been strapped for cash and have had to forego buying other necessities, such as health insurance or paying for a child’s college tuition, paying off your mortgage will give you more available cash for other monthly expenditures.

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Lenders make money on the interest they charge borrowers and some lenders (not all) don’t want that incoming interest to end, so they include a prepayment penalty in their mortgage contracts. If your contract contains such a penalty, you can expect to pay a small percentage (around 1-2%) of the remaining loan balance to the lender if you pay the mortgage off early. A prepayment penalty usually only applies early in the loan—such as within the first five years—and after that it expires. Check the terms of your contract, if it contains a prepayment penalty that expires soon, consider waiting until it expires to pay off the mortgage.

Paying off a mortgage early doesn’t mean you’ll pay less on the loan’s principal (the actual amount you borrowed to buy the house), but it does mean you won’t have to pay interest (the extra amount the lender charges you for the privilege of borrowing the money). Depending on the amount of interest you’re paying and how long you have left to pay on the loan, you could save tens of thousands of dollars if you pay off your mortgage early. Check out this mortgage payoff calculator to see just how much you could save.

While paying off your mortgage early means more monthly cash flow now, if you haven’t yet established a retirement savings, that might be a better use of your money. Again, this all depends on your current loan and interest rate, but by putting money in an individual retirement account (IRA) or 401(k), your invested money will enjoy tax-deferred growth until you draw it out upon retirement. The gains could be more than the amount you save in interest by paying off a mortgage early, especially if you’re near the end of your mortgage (within a year or two).

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It’s satisfying to know you own your house outright—no mortgage—but if spending your entire savings to pay off the loan early leaves you without an emergency fund, you could end up regretting it. If you pay off the mortgage and later find yourself in need of funds, you might have to take out a home equity loan—with your home as collateral—which often come with higher interest rates than standard mortgages. Before paying off your mortgage, be sure you have at least six months of living expenses saved in case of emergencies.

Depending on how you file your income taxes, you could lose a deduction if you pay off your mortgage early. If you itemize expenses using Schedule A, you are allowed to deduct the amount you pay in interest on your home loan. Participate in a quick interview using the IRS’ Interactive Tax Assistant (ITA) to learn whether you qualify to take a mortgage interest deduction. In general, about 30 percent of taxpayers itemize deductions but for the rest of the filers, the standard deduction will amount to more than itemized deductions, so for most taxpayers, this will not apply.

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While home loans in the 1980s and 1990s came with some steep interest rates (up to 14% at one point), most of those mortgages have been refinanced at lower, 3.25% to 5.0%, rates in the past decade, according to Freddie Mac. Before paying off your mortgage if you have a low interest rate, first pay off any outstanding revolving credit accounts, such as credit cards and store cards, which come with interest rates ranging from 11% to as high as 25%, depending on your credit score, according to WalletHub.

If you purchased your home within the last decade—or had it refinanced—you’re likely paying a fairly low interest rate. If you use money you have saved up (or inherited) to pay off your mortgage, sure, you’ll save on interest. If, on the other hand, you invest that same amount of money in a Standard and Poor’s (S&P) 500 index fund (a basket investment including the 500 largest American companies), you could potentially earn an average of 10% on your investment annually, according to Forbes, which is more than you would save paying off a low-interest mortgage.

If you’d like to reduce your monthly mortgage payment but you’re not ready (or in the financial position) to pay off the balance right now, consider refinancing if you purchased your home more than 15 years ago and still have more than 10 years left to pay on the loan. Because interest rates have dropped, you may be able to keep the same number of years on your loan, while paying a few hundred dollars less each month. The rate you qualify today will depend on your credit score, but it doesn’t hurt to call your lender and find out what options are available to you.

You’ll reduce the amount of interest you pay on your mortgage over time—without needing to pay off the entire amount now—just by paying a little bit more toward the principal every month. There’s a trick to this, however, don’t just add a hundred dollars to your monthly payment or your lender may apply the extra to future payments and not the principal. Rather, make two separate payments, one for the regular monthly payment, and a second one that specifies it is to be applied directly to the loan’s principal.

Related: 11 Tips for Getting a Loan for Your Next House

A lot goes into making good financial decisions for your family, and sometimes the best way to go about it is with a little professional help. Understanding whether paying off a mortgage early is in your best interest can be confusing and, in the long run, it depends on many factors, such as how much you currently have saved for retirement, what your income-to-debt ratio is, what your short- and long-term financial goals are, and whether you have other investments. Consulting with a licensed financial advisor could cost $50 to $300 per hour, but you could save thousands by doing so. SmartAsset’s Financial Advisor Locator can help you find a qualified financial advisor in your community.