Q: My mother is in her late 80s and is of an era where owing money is not a good thing. She regularly reads your column and keeps insisting that I should pay down my home loan. She has even offered me money to do that. My interest rate is less than 4%. Is she right?
A: It’s good to know somebody is paying attention to the idea that prepaying your mortgage can save you tens of thousands, if not hundreds of thousands of dollars over the life of the loan.
In general, she has the right idea. Prepaying your mortgage is a smart way for most Americans to build wealth. Every payment repays a bit of the loan balance. Prepaying speeds up that process, saving you interest as you only get charged interest on the loan balance that’s outstanding.
Most homeowners have the vast majority of their wealth in their homes. One argument against prepaying is you’re locking up your cash in a relatively illiquid asset. That’s true, but you can usually take out a home equity loan or do a cash-out refinance, if you need to be more liquid. In the meantime, you’re saving money.
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In a time when inflation is extremely high, prepaying your low-cost mortgage may not be the best idea. Millions of homeowners refinanced when interest rates were at historic low levels over the last few years and now have extremely low monthly payments. If you refinanced and got an interest rate of 2.5% or 3% on a 30-year fixed-rate loan, you may be able to earn substantially more than that by investing the money in a variety of assets, including I-bonds, which pay above the rate of inflation, or in the stock market, which is currently in a bear market but may still offer better long-run returns.
So, when does it make sense to prepay your mortgage? Right now, interest rates on a 30-year fixed-rate loan are bouncing between 4.5% and 5.5% for consumers with credit scores over 760 or 780. If your credit score is lower, you’ll pay even more. That’s twice as high as interest rates were in 2021. Still, some people are buying homes. If you do buy a home and have a higher interest rate, prepaying your mortgage might make some sense, unless you have a better place to put the cash. Or, you’re just scraping by financially.
If you really can’t sleep at night because you’re allergic to debt of any kind, then go ahead and prepay your mortgage.
We also think that if you’re nearing retirement, and will be living on a fixed income once you get there, prepaying your mortgage is a smart move.
In retirement, you may not want a mortgage payment to deal with on top of property taxes and higher overall living expenses given the inflationary times. Freeing up cash flow as you head into your post-work life makes sense.
In inflationary times, rising prices can mess with tight budgets. Rather than spending extra money to prepay a low-cost mortgage, you’re better off socking away or investing that cash to help cover escalating costs over the next few years until inflation gets under control.
Your mother is probably experiencing this every time she goes to the grocery store or looks to fill up her car with gas. She’s worried about you, even though retirement is probably at least a decade away. She knows, because she’s in her 80s, that life can be long and full of surprises, some of which will be less than pleasant. She probably also knows that having enough cash on hand can help get you through tougher times.
But you can manage all of this without spending extra cash when your mortgage payments are virtually interest-free. Overall, we like the idea of prepaying your mortgage. We’ve done it and we love being mortgage-free.
But right now, if your mortgage carrying costs are low and fixed, don’t mess with that. Focus on saving as much as you can and continuing to assure your mom that you are doing fine.
(Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through their website, bestmoneymoves.com.)