Does a Fast Payoff Make Sense?

September 18, 2000, Revised August 28, 2011

"My husband and I will be buying a house at the end of this year. We believe we should be able to pay off the home in 7 years by more than doubling our payment. We have been told that we are insane if we do this because we won’t get the full interest deduction benefits, we could invest our extra money elsewhere, etc. Would we be crazy to pay our home off in as little time as possible?"

Define and then assess the alternatives. If you don't use your extra income to repay your mortgage, how would you use it?

You could spend it in any number of ways: have more children, travel the world, or fund a retirement home for impoverished finance professors. These are investments that yield no direct financial return, and I can’t advise you on them. They reflect life-style decisions only you can make.

If you plan to invest the money for a financial return, compare the risk and return from prepaying your mortgage against that of other investments. The return on prepaying the mortgage is the interest rate on the mortgage. The return caries zero risk to the borrower. See What Is the Yield on Mortgage Prepayment?

When I first wrote this piece in 2000, mortgage rates were around 8%, and the low-risk alternative of putting the extra income in a bank or money market fund yielded only 3-6%. When I revised it in 2011, mortgage rates were closer to 4% and the alternative yields were closer to zero than to 1%. To a risk-averse investor, paying down the mortgage balance was the best investment in 2000, and in 2011.

For an investor prepared to assume some risk, a diversified portfolio of common stock could yield 9-12% or more. That might make sense, provided you are in your 30s or 40s, are prepared to see your investments fluctuate in value, and plan to stick with it over the long haul. If you are in your 60s or beyond, a stock market tumble could crack your nest egg. See Pros and Cons of Mortgage Prepayment by Seniors.

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