Pay off your mortgage early or save? How to decide

When you closed on your home mortgage, you may have felt an unmistakable thrill as those house keys finally landed in your hand.

However, you may also have felt a bit anxious about the “paying off the mortgage” part of your new housing adventure. If you have a mortgage, you’re not alone: Right now, most Americans who own a home still have a mortgage (and many are probably anxious about those payments as well). Only about 1 in 3 U.S. homeowners never had a mortgage or have paid it off. ¹

A mortgage may be the biggest debt you ever take on. After all, you could be making monthly mortgage payments for up to 30 years. And over that time, you might end up wishing you had extra money for anything from fixing your car’s transmission (oh, no!) to a great business opportunity (heck, yes!).

Answering the big question

So if you have some extra money, what’s the best thing to do with it? Should you try to pay off your mortgage early and get rid of that debt? Or are you better off continuing to pay your mortgage and putting any extra cash in savings?

The decision isn’t a slam-dunk. The best option really depends on your financial situation and your money goals. It’s one of the most hotly contested debates of the financial world: Should you pay off your mortgage early or save your extra cash?

If you’re asking this question, that’s a sign that you’re in a great financial position. It means you have some money left over each month after paying bills, and that’s no easy feat.

The decision to either prepay your mortgage or build up your savings isn’t easy either. However, the good news is that both options make financial sense. The best choice depends on your financial situation and your money goals.

Here are a few questions to ask as you choose between paying off a mortgage early or piling up extra savings.

Are you taking care of other financial priorities?

Before considering the mortgage vs. savings question, review other financial goals:

• Have you saved an emergency fund of 3 to 6 months’ worth of critical expenses?

• Are you debt-free? Other debts you may have include student loans, car loans, medical payments and credit card balances.

• Are you putting 10-15%² of your income toward retirement?

If you answered “no” to any of these questions, consider taking care of those priorities first. But if you’re in good shape on all of the above, then get out your pro/con list: It’s time to compare paying off your mortgage early or putting extra money in savings.

Advantages of prepaying your mortgage

If you’re looking for reasons to justify getting rid of your monthly mortgage, here are a few:

• You pay less in mortgage interest: Once you’ve paid off your mortgage, you also stop paying the interest on it (the extra cost for taking out a loan). On a $200,000 house, you could possibly save more than $15,000 in interest charges.

• Here’s how the math works: If you buy that house at 4% interest (after a 10% down payment) you have monthly payments of $860. By adding a little more to each mortgage payment—perhaps an extra 1/12th of a month’s principal and interest ($86)—your total monthly payment is now $945. With that one change of $86/month, you’ll pay off your 30-year mortgage 3 years and 7 months early, saving a hefty $15,357 in interest charges.

• You free up money for other expenses: Once you no longer have a monthly mortgage payment, you can pop that money into a savings account. You might later use it to pay for things like kids’ college tuition, a second home or retirement. You won’t be entirely free of house payments, however: You’ll continue paying homeowners insurance and property taxes.

• It increases your financial security: Having a paid-off house can help lower your financial stress level. Why? If you hit a financial rough patch, you may face less chance of losing your home if it’s already paid off (or close to it).

Consider this, too: One drawback of paying off your mortgage early is that it isn’t easy to “withdraw” the extra money from your house in a financial emergency. You may want to open a home equity line of credit as a backup option so you have extra funds to draw from if necessary.

How to pay off a mortgage early

If you decide that paying off your home loan early is right for you, what’s next? Start by checking in with your mortgage servicing company. Did you know you might have to pay a penalty for making extra payments, depending on what’s written into your mortgage contract? Also, find out how to make sure your prepayments are correctly credited to your loan.³

There are a few ways you can prepay your mortgage:

• Make half payments every 2 weeks (biweekly): This clever strategy means you’ll end up making one full extra mortgage payment per year. Making 26 half payments (52 weeks in the year divided by 2) is the same as making 13 full payments. If you get paid biweekly, consider setting up automatic transfers from your bank account to your mortgage.

• Increase your monthly payment: This is another way to make an extra monthly mortgage payment a year. Divide your regular payment by 12 and add that amount to your monthly bill. For instance, if your monthly payment is $860, divide that by 12 $72). Add that extra $72 to your monthly bill.

• Use bonus money: Pay extra toward your mortgage whenever you get a work raise (U.S. average raise is about 3%⁴), tax refund or other unexpected money.

• Refinance your mortgage: You may be able to get a lower interest rate and/or choose a shorter loan term, such as 20 years instead of 30. Both choices can help you save money and pay off your mortgage faster.

The other choice: Advantages of putting extra money in savings

Prepaying your mortgage early can sound like a smart move. But what if you have other big-ticket items coming up? Think wedding, big vacation or college tuition. For those moments, you may want to have extra cash on hand, instead of tied up in your prepaid mortgage.

What’s good about increasing savings?

• You’ll have access to extra cash: Starting a business, getting in on a smart investing opportunity or even paying off unexpected medical bills—all of these situations require money in the bank, rather than in a house. If you run into an unexpected money need, your mortgage servicer can’t hand you back your extra mortgage prepayments.

• You’ll hang on to your mortgage tax benefits: In most cases, mortgage interest is tax-deductible. That’s a nice savings. Once you pay off your loan, the related tax break goes away, too.

• You give yourself extra financial security: A good example is if you work in an unpredictable industry or your job is a bit uncertain. In a case like that, you may want to bulk up your savings. Consider saving even more than the 3-6 months’ worth of expenses many experts recommend for an emergency fund.

Still, choosing between paying off your mortgage early and putting extra money into savings? No worries. Figuring out what your money goals are, how much other debt you have and what types of expenses are coming up can help you decide which option makes the most sense for you. Either way, having extra money available to put toward one of these goals is a good thing!