To Pay Off, or Not to Pay Off – Your Mortgage Early, that is

If I should ever find myself with a windfall, should I pay off my mortgage in one fell swoop?

A frequently asked question about mortgages is:  If I should ever find myself with a windfall, should I pay off my mortgage in one fell swoop?

Answer:  It depends on your whole financial situation. Ideally, discuss the idea with someone objective who you can trust to give you an honest assessment before you take any action.

Your house is not a liquid asset. Your primary objective in owning a house is to live in it, so you are not likely to sell it in the first place. Secondly, even if you decided to sell your house, and it is so fabulous that it sold on the first day for the full asking price, it still may be several months before closing, when you can finally unlock the value. This means that whatever you put into your house you are not going to be able to get out easily. Can you afford to lock up that extra cash?

The answer may be yes if you have no other debts and you have so much money saved for retirement, your kid’s college, and all your other dreams that you cannot imagine how you are going to spend it all in one lifetime.

Not you? Join the club. So, what should you do with that windfall?

If you have credit card debt, you would probably want to use your windfall to pay this off first. The interest on credit card debt is generally some of the highest and it is not tax-deductible like your mortgage.

Line up your debts by interest rate with the highest interest rate being paid off first, then the next highest and so on. Even if you cannot pay off a debt in total, taking a big bite out of a huge loan balance—like a student loan—will make you look better on your credit report.

Let’s say you paid off your credit card debt, your student and car loans, and you still have money left over.

If your mortgage has a really low interest rate, like under 4%, one needs to ask the question: Can I make more than 4% with this extra money? If I can invest the money and make a net 5% or more, then it makes more sense to put the windfall to work in an investment portfolio and keep making the regular payments to the mortgage.

The interest you pay on your mortgage is tax deductible, so you are actually paying less than the locked-in interest rate when you consider the tax advantage. You must also consider the power of inflation on the money you are using to repay the loan. If you paid a 30-year loan over the whole 30-year period, the first dollar you use to pay on your mortgage will have much more buying power than the last dollar you use.

So as usual, there are no pat answers. If you find yourself at cross-purposes with your mortgage partner, engage a trusted advisor to help you find the right solution for your particular situation.

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