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Should you pay off your mortgage early?

When you buy a home, the thought of a mortgage hanging over your head for 30 years can be daunting and it’s natural to want to pay off your mortgage as soon as possible.

But before you decide to use your annual bonus or your savings to pay part or all off your mortgage principle (or even before you decide to make extra payments), it’s important to take a step back and determine whether it really makes financial sense for you.

You need to consider if the amount you save on interest when you pay off your mortgage early exceeds what you would earn if you put the money to work elsewhere. On the other hand, sometimes it’s not about the return on other investments and more about peace of mind or freeing up cash flow for other opportunities.

Here’s what you need to know as you decide whether to pay off your mortgage early.

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Alternatives to paying off your mortgage early

The biggest consideration is whether to pay off your mortgage or invest. What if, instead of putting money towards paying off your mortgage early, you invested the cash elsewhere?

According to Trend Economics data, home loan rates averaged 4.16 percent from 1990 till 2020. And for the same period data from Vanguard shows that returns from Australian shares averaged 9.4 percent per annum.

Existing mortgages today have rates averaging 3.19 percent (owner occupiers) to 3.55 percent (investors) based on RBA’s outstanding loans data, so if paying off your mortgage early leads to a return equal to your interest rate, that return is somewhat dismal!

Of course, you could be a smart investor and take the cash you’d use to pay off your mortgage early and leverage it into buying a cash-flow-positive property that are desirable family homes located in up and coming suburbs that have the potential to experience significant capital gains.

No one can give you a guarantee on an investment return, no matter what they claim. You can put your money in the stock market and lose it. You can put your money in real estate and it doesn’t perform as well as you expected it to.

Any choice is a risk, however. Even after paying off your mortgage early, real estate prices could plunge, leaving you with a potential loss. Carefully consider which risks you’re willing to take. You might be better off not paying your mortgage off early.

Pros and cons of paying off your mortgage early

Pros

·       Freeing up substantial cash flow that can be useful, especially during retirement if directed into fattening up your Super balance.

·       Save money on interest, potentially thousands of dollars.

·       Receive a predictable rate of return, equal to the interest rate on the debt you’re paying down.

·       Peace of mind, know that you are debt-free.

·       It’s possible to tap the equity in your home if you need money later.

Cons

·       Ties up a good chunk of your liquidity and net worth in your home, and it might be hard to access it later if the property values fall.

·       It can be difficult to sell the home quickly if you lose a job or if there’s an emergency and you need money fast.

·       You miss out on the potential for higher returns from other investments.

Bottom line

It’s important to figure out what works best for your situation and is most likely to help you reach your short- and long-term financial goals.

For some, owing money causes stress and paying off the mortgage early can bring peace of mind. For people nearing retirement, a paid-off mortgage means they have that much more free cash flow from their fixed post retirement income. Choose wisely.

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This article does not constitute advice; readers should seek independent and personalised counsel from a trusted adviser that specialises in property, a tax accountant and property design specialist.