After finding the perfect home and signing mounds of paperwork, the house is yours, along with a shiny new home mortgage. Many homeowners find such a large amount of debt to be daunting, and they may wonder if it is financially prudent to pay extra to their home loan. Before sending that extra payment, it is vital to consider your entire financial picture, personal comfort levels, and overall financial goals.
Do You Have an Emergency Fund?
Financial gurus recommend an emergency fund equal to three to twelve months of expenses, in case of job loss or other emergencies. Homes are also notorious for requiring costly repairs, such as a new roof or heating system. If your cash reserves are low, stow extra money in your savings account to ensure you have the necessary funds to cover unexpected situations.
Can Your Money Earn More Elsewhere?
When you pay extra towards your mortgage, your money earns a guaranteed return based on the loan's interest rate. However, home mortgages are popular because they have low interest rates. Even though paying extra to your mortgage may give you a return of three, four, or five percent, this is relatively low compared to other possibilities.
If you have credit card or personal debt with high interest rates, it makes sense to put extra money towards this high interest debt, not your low interest mortgage. Paying more than your minimum credit card payment is a simple way to slash interest costs, saving buckets of money in the long run.
Homeowners with no other debt may find that investing in the stock market gives them more bang for their buck in the long term. From 1928 through 2010, the S&P 500 had an average return of 11.31 percent. Individuals who are comfortable with risk and can invest their money for long periods can earn a higher potential return.
A Case for Extra Payments
Many individuals achieve emotional comfort knowing that they are taking steps to have a paid off home. Paying extra to your mortgage also helps reduce your balance so that you can get rid of costly private mortgage insurance (PMI) sooner than expected.
Extra payments obliterate the interest expenses associated with a mortgage. Assuming that you have a 30-year mortgage with a balance of $200,000 and a five percent interest rate, you will pay $186,512 in interest over the life of the loan. By making a single extra payment every year, you can pay your home loan off in 26 years and save a whopping $32,699 in interest.
When it comes to making the decision to pay your home loan off early, there is not a singular right or wrong answer. Take time to examine your preferences and financial situation so that you make a decision that satisfies your financial and personal goals.