Should You Pay Extra on Your Mortgage?

Real estate legal experts are generally divided—pro and con—on the issue of whether or not homeowners should pre-pay their mortgages or pay extra every month. The specific advantages and disadvantages of this financial option are highlighted below.

Pre-paying Your Mortgage

PRO: If you are approaching retirement age, being able to pre-pay a mortgage and own a home outright might offer some peace of mind. This would hold especially true if you are living on a fixed income.

PRO: Even for some homeowners not approaching retirement age, repaying your mortgage may be preferable to regularly investing in a tax-deferred retirement account for reasons of liquidity alone, another peace of mind issue.

CON: By pre-paying your mortgage, you lose your mortgage-interest tax break.

CON: Your mortgage lender may assess a pre-payment penalty if such a clause is included in your agreement. Since some mortgages include hefty mortgage pre-payment penalties, affected homeowners should determine how negatively such a penalty might impact any financial savings that could have been gained had there been no pre-payment penalty. Most fixed-rate mortgages do not include pre-payment penalties. They are more likely to be included in variable-rate mortgages.

PRO: For those homeowners with variable-rate mortgages, if there are no pre-payment penalties included in the mortgage, the ability to pre-pay when interest rates are rising can be advantageous.

PRO: For those homeowners with a positive cash flow and minimal credit card balances, pre-payment makes the best sense. Unfortunately, these homeowners are in the minority.

Paying Extra Every Month

PRO: For those homeowners with fixed-rate long-term mortgages, paying extra each month on your mortgage may shorten the life of the loan—if you apply the extra payments toward the mortgage's principal only, not the interest. Note that this will shorten the life span of the loan, but will not reduce the regular monthly payments.

PRO: For those homeowners paying down (at least for the initial years of the loan) on interest only, extra payments will indeed produce savings on future interest and shorten the lifespan of the loan. On average, it takes 10 years of a 30-year mortgage before mortgage payments begin to chip away at the principal. To do your own long-term projections on paying extra on your mortgage, consult one of the many reputable mortgage calculators available online, including Bloomberg (at http://www.bloomberg.com/invest/calculators/mortgage.html) and Kiplinger's (at http://partners.leadfusion.com/tools/kiplinger/home16/tool.fcs).

CON: For those homeowners with variable-rate mortgages, paying extra on interest would have little upside on the life and amount of the loan during an economic climate where interest rates are rising. Because you will only begin to see your interest savings some time in the future, take into account how future inflationary economic conditions might negatively impact these projected savings.

CON: According to certain consumer financial pundits, including Consumer Reports, paying extra each month on your mortgage may not outperform stock market investment trends in the long run. This, of course, assumes that historic long-term stock market cycles will repeat themselves.

PRO: Stock market investments are taxable and include fees. Extra mortgage payments on your mortgage's interest are deductible from your income tax if you are a taxpayer who takes itemized deductions.

Things You May Want to Pay Instead of a Mortgage

In most cases, it is preferable to pay extra on credit card debt that bears a higher interest rate than your mortgage.

In some cases, it may be more advantageous to pay extra into your family's emergency fund to protect against unexpected expenses, especially in an economic climate with massive layoffs. For some, this may also trump paying off high-interest credit card debt.

Investing your extra money in a life, health, or long-term disability insurance plan may make even more sense in the long run than maintaining a household emergency fund, particularly if you have dependents. Medical expenses are a reality that may present a heavier and more immediate household burden than mortgage debt.

For homeowners with children, college is another major expense to consider. It may prove more advantageous for your family to invest extra money into a college savings plan rather than saddle a young graduate with student loan payments.

It may also be more advantageous for some home-owners to invest in certain tax-deferred retirement accounts because they can offer economic growth as well as tax savings.

For those homeowners working for companies with a 401(k) plan, it may make more sense to invest extra money in such a plan, particularly if your employer offers investment matching.