If you’ve ever considered paying off your mortgage three, five or even 10 years earlier by making extra payments, you’re not alone.
Ross Mannino, a financial adviser and managing director at Ameriprise Financial Services, told CNBC Select that clients come to him with this idea all of the time.
For some homeowners, like those with higher interest rates, a stocked retirement fund and no other debt, it may be the best move. But for many others, the decision could ultimately mean missing out on tens or hundreds of thousands in retirement savings or accruing more interest than necessary on bad debt.
To help you avoid losses and maximize gains, we asked Mannino, a certified financial planner, what you should consider when deciding whether to make extra mortgage payments — and where you may want to think about putting that extra cash instead. While it’s crucial to talk to a financial adviser when contemplating many financial strategies, these five questions can help you determine whether this strategy may be right (or wrong) for you.
1. Is it within your budget?
Before you allocate any additional funds to an extra payment, Mannino recommends reviewing your earnings and expenses to determine whether you can comfortably afford it.
“The first thing I always ask clients who ask me this question is ‘do you have that extra cash flow?'” he said.
Make sure you have enough for monthly expenses, retirement savings and a robust emergency fund with three to six months’ worth of expenses. To help calculate your cash flow, you can download a free budgeting tool.
2. What is your mortgage rate?
Your mortgage payoff strategy should vary based on your rate.
People who took out their home loans between 2018 and 2023, have interest rates that are “probably pretty darn low,” Mannino said. That could include rates in the 2% or 3% range. But those who took out debt in the past three years may have rates as high as 8%.
With inflation at 2.7%, it may make sense to put your money in a high-yield savings account or certificate of deposit where you can get a better rate of return if your rate is over 3%.
Making that extra mortgage payment “wouldn’t be the first place I would go to if you had a 3% mortgage,” Mannino said. “I think anything above 4.5% and 5%, it’s a discussion.”
3. Do you have other debt?
The next question continues to focus on debt.
You should determine whether your mortgage is the best part of your debt portfolio to pay off first. Here’s why it may not be:
- There’s a good chance your mortgage is your cheapest debt, meaning it has the lowest rate. You’ll be accruing interest more slowly than you would on a credit card, which had an average rate of 20% as of February, or a student loan, which could have a rate as high as 18%.
- A mortgage is “good debt,” meaning the asset —which, in this case, is your home— is appreciating in value. Student loans and business loans are other forms of “good debt.”
Before you pay off your “good debt,” you’ll want to get rid of “bad debt,” like credit cards or car loans, Mannino said.
Bad debt is used to finance something that is losing value. The longer it takes for you to pay it off, the more you’ll be losing in interest payments to an asset that won’t give you anything in return down the road.
After that, if your goal is to become debt-free, you’ll want to pay off any good debt with higher interest rates before turning to your mortgage.
4. Does it make more sense to put that extra money in a retirement fund?
Once your “bad debt” is paid off, you should decide whether it’s better to put that extra money toward other financial goals, like saving for retirement.
This is where you will need to do some math — and this is also where having a CFP or wealth manager would help.
CNBC Select crunched the numbers to compare the strategies of paying off a mortgage or putting those funds into a 401(k).
Making one extra yearly payment on a $300,000 30-year mortgage with a fixed-rate of 6.25%.
- Monthly mortgage payment: $1,847.15
- Extra payment per year: $1,847.15 (or $153.93 monthly)
- Total extra payments made: $55,414.50
- Total repayment length: 25 years, 5 months
- Total savings on interest: $80,269
Instead, here’s how it would look if you put that extra monthly mortgage payment into your 401(K) annually.
Imagine you implemented this strategy between the ages of 30 and 60, retired at 65 and assumed an annual yield of 8% — the average between 2020 and 2025, according to Vanguard.
- Extra yearly deposit: $1,847.15 (or $153.93 monthly)
- Total deposited: $55,414.50
- Total yield: $404,166.00
The homeowner in this example would net over three times as much in the long run by putting the extra cash in their retirement fund.
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5. Are you paying for PMI?
One reason you may want to prioritize that extra mortgage payment is if you’re paying for private mortgage insurance (PMI).
If homebuyers make a down payment of less than 20% of the home’s purchase price, they are typically required to maintain PMI until they have built enough equity to meet the 20% threshold.
PMI ranges from 0.1% to 2.0% of the loan balance each year. On a $400,000 mortgage, that would be about $400 to $8,000 annually.
That’s money that you will never get back, so you’ll want to get to that 20% equity mark as soon as possible by making extra mortgage payments — even if that money could have grown faster in a retirement or savings account than interest would on your mortgage.
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