Why It May Be a Bad Idea to Pay Your House Off Early

The desire to pay off your house early is not inherently wrong. In fact, it likely shows that you are trying to create a financial plan that is best for yourself and your future. However, before you go attack your mortgage with a vengeance, it is important to do a proper analysis of the situation.

In order to do this, you need to understand opportunity cost. Opportunity cost is an economic term. When you make a decision to choose one option, you lose the opportunity of another option. For example, say that you are a parent and have a young child.

You tell your child that they can have dessert after lunch or after dinner, but not both. If your child chooses to have dessert after eating lunch, they will not be able to have dessert after dinner. The opportunity cost of your child choosing to have dessert after lunch is that they lose out on the opportunity to have dessert after dinner.

So, how does opportunity cost relate to paying off your house early? In order to pay off your house early, you need to make extra payments to the principal of your mortgage. When you make extra payments to your house, you lose the opportunity to use that money for other purposes.

For example, let's assume that you are able to put an extra $300 towards your mortgage each month. Over time, you will pay down your mortgage faster. However, what did you miss out on? You missed out on the opportunity to use that $300 per month for other purposes.

Instead of putting that $300 towards your mortgage to pay it off faster, you could invest that money. You won't pay off your house as fast, but you will build wealth at the same time as your mortgage goes down. We are going to look at an example to compare the differences between these two options to help you understand what to do with your available dollars.

We are going to show what it would look like to pay off your house early and what it would look like to wait to pay off your home. In order to do this, we are going to look at the same hypothetical example to show the differences in the two scenarios.

For sake of example, let's assume that you just bought a new home. The purchase price of the home was $400,000. You bought it using a 30 year fixed mortgage that has a 6% mortgage rate. To keep things simple, we are going to assume that you put 20% down on the home.

If you were to pay the loan off over the 30 year period, your monthly payment would be $2,343.56. Over the course of the loan, you would pay out $370,682.20 in interest - ouch. You have heard that paying off your mortgage early will save you interest. This seems like a smart financial decision to you so you decide to go for it.

After reviewing your budget, you think that you can put an extra $500 per month, or $6,000 per year towards the principal of your mortgage. By doing this, you will pay off your remaining balance in 18 years and 5 months. This is 11 years and 7 months faster than your original 30 year term.

Additionally, the total interest paid out during this period is $210,715.95. This is a savings of $159,966.25 when compared to the original mortgage terms. At this point, paying off your house early is looking like a good decision. However, it is not a complete analysis. Let's look at an alternative option below.

In the example above, you saved interest by paying off your house early. Everyone always wants to focus on the interest they saved. This is not inherently wrong to do. However, very few people think about the interest that they lost out on.

This is where opportunity cost comes into play. When you sent an extra $6,000 towards your mortgage each year, you lost out on the opportunity to use those dollars elsewhere. If there is a better place to send those $6,000 per year, paying off your house early is not an intelligent financial decision.

The alternative to paying off your house early is to wait to pay off your home. You are not technically "waiting" to pay off your home, but instead are following the original terms of your loan. We are going to use the same assumptions as above.

You bought a $400,000 home with a 20% down payment, and have a 30 year fixed mortgage with an interest rate of 6%. For this second scenario, you are not going to pay off your home early. In the first scenario, you had an extra $500 per month, or $6,000 per year that you were putting towards your mortgage.

Since you are not going to use this money to pay off your house early in this second scenario, the question becomes what you should do with it? You could go out and spend it on your lifestyle, or you could be smart and invest it.

You decide to do the latter. You plan to invest the extra $500 per month into the stock market as you pay down your mortgage over the next 30 years. You assume that you can get a compounding return of 10% per year from the stock market over the 30 years with the ups and downs of the stock market.

Using the assumptions above, your investments in the stock market would be worth $986,964 at the end of 30 years. Your mortgage would also be paid off. So, let's compare this scenario with the first scenario to show the differences.

In the first scenario, you paid off your home early. This saved you 11 years and 7 months worth of mortgage payments and $159,966 in interest. In scenario two, you paid off your house in 30 years, but ended up with almost $1 million worth of stocks.

Simply by allocating your $500 to the stock market as opposed to paying your mortgage off faster, you are now $1 million richer. The point of these examples are to show that the best financial decision is not always to pay your house off as fast as possible.

One of the main arguments you will hear in favor of paying off your house early is that it frees up your income to do other things with. This is undeniably true. If you no longer have a mortgage payment, you can take the dollars that you would have sent to your mortgage and use them elsewhere.

However, you have to look deeper into this idea to see if it is smart or not. Let's revisit the initial scenario that discussed paying off your house early. Remember, you bought a $400,000 home and put 20% down. You had a 30 year mortgage with a 6% mortgage rate.

When you put an extra $500 per month or $6,000 per year towards your mortgage, you would pay it off in 18 years and 5 months. However, if you were to invest that same amount of money your house would be paid off in 30 years and you would have almost $1 million worth of stocks.

Here lies the question. Could you take all the extra money that you save by paying off your mortgage early and invest it to reach the same result? What does this mean exactly? Once you pay off your home early, you no longer have a mortgage payment.

Let's also assume you still have an extra $500 per month to use once your house is paid off early. You saved 11 years and 7 months worth of mortgage payments. Now that your income is freed up, could you take all those extra dollars and invest them over the next 11 years and 7 months to reach the same result as you would have by waiting to pay off your mortgage in 30 years?

Let's find out. Your mortgage payment was $2,343.56 per month. However, since your house is paid off you no longer have that payment. You can now invest that $2,343.56 as well as the extra $500 per month over the next 11 years and 7 months.

This gives you a total of $2,843.56 per month to invest over the next 11 years and 7 months. Assume that you can get a 10% return by investing that money in the stock market. At the end of this period, you would have $729,546.

How does this compare to paying off your mortgage in 30 years? When you paid off your mortgage in 30 years and invested $500 per month, you ended up with $986,964. The difference between the two scenarios is $257,418.

It is true that you free up your income by paying off your house early. However, you would still be about a quarter of a million dollars worse off when you pay off your house early and then use all of that extra money to try to catch up on investing.  

One of the biggest arguments for paying off your home early is the emotional impact that it will have on you. You will hear statements such as ,"Imagine how much better your life would be if you did not have a mortgage payment to make each month."

These sentiments are understandable. Many individuals who pay off their home early do feel relief and an increased feeling of financial security. As previously noted, the desire to pay off your home early is not inherently wrong.

However, don't fall into the trap of believing that paying off your house is the best financial decision because it will make you feel better. As demonstrated in the examples above, paying off your house early can cost you hundreds of thousands of dollars.

How will you respond emotionally if you know you made a decision that cost you hundreds of thousands of dollars? In the moment, paying off your house early can appear to be the best decision, but you might regret it later on once you understand the opportunity cost of sending extra payments to your mortgage.

You can pay off a mortgage, but you can't pay off housing. One of the biggest misconceptions is that when your mortgage is paid off, your house is paid off. This is not true. There are other expenses that you will have to pay for as long as you live in your home regardless if the mortgage is paid off or not.

These expenses include insurance, property taxes, and property maintenance. You will always have to spend some amount of money to live in your home. The point here is to help you understand that you can never pay off your housing.

For this reason, it is not always the best idea to focus on paying off your mortgage as fast as possible. Instead, it can be better to allocate your dollars to other areas like investments. This idea has been clearly demonstrated throughout this article.

The bottom line is that it is not inherently wrong to want to pay off your house early, but there may be a better way to do it. When you choose to send extra payments to your home, you miss out on the opportunity to use those dollars in other areas.

If you can send extra dollars to investments that can earn a better return for you than paying off your mortgage, it is not a good idea to pay off your house as fast as possible. Remember, you can pay off a mortgage, but you can't pay off housing.