Pros and Cons of Paying Down Your Mortgage
Should you pay down your mortgage more aggressively? This is something that’s asked a lot on BiggerPockets, and rightfully so—it’s a great question.
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There is no right or wrong answer here. It all depends on your short- and long-term financial goals.
The fact is there are pros and cons to paying down your mortgage. In this post, I’ll discuss the amortization schedule, payment schedule, and impact of paying down your mortgage faster. I’ll also discuss the effect it can have on your taxes.
With this knowledge, it’s my hope you can create a well-informed strategy about whether or not to aggressively pay down your mortgage.
Building Wealth: The Pros and Cons of Paying Down Your Mortgage
Most, but not all, of this information will apply to both your home and to rental properties. Your mortgage payment is broken down into two parts: the portion that goes toward your principal and that which goes toward the interest on the loan. (Some mortgage statements also have another line item called "escrow," but I'm not going to talk much about that today.)
Whether or not you want to pay down your mortgage quickly is largely dependent on whether you’re focusing on immediate personal cash flow or long-term wealth building.
If you’re paying your mortgage down aggressively, you’re paying more of the principal. Most mortgages are set to get paid down over an amortization schedule, which is somewhere between 15 to 30 years.
In the beginning, you're heavily paying off the interest. But as the years go by, you're paying less and less interest because you owe less money on the loan overall.
So, those who add in an extra payment amount on the top of what they owe monthly are essentially paying off more of their principal upfront, decreasing the amount of interest they’re paying in a shorter timeframe.
Pros of Paying Off Your Mortgage Faster
By paying off your mortgage quicker, you’ll own the property free and clear sooner. And without a mortgage payment, you’ll be cash flowing a much higher amount (that is, if it’s a rental property).
If real estate investing is not your full-time gig (it’s more so passive income), it’s beneficial in the long term to pay off your mortgage faster. Then, when you retire, you’ll be generating a higher amount of income off those rental properties that you own outright.
Another thing to consider is that five or so years into your mortgage, the bank is likely to change the interest rate on your loan. Maybe it will go up; maybe it will go down. The faster you pay off your principal by adding a little extra on top of what you owe each month, the more you've given yourself a little hedge when the bank comes around and changes your rate.
Cons of Paying Off Your Mortgage Faster
There happens to be no tax advantage to paying down your mortgage faster. The only part of your payment that’s tax deductible is the interest portion. The more principal you pay and the more cash you’re flowing, you’re going to be paying more in taxes.
And if you’re looking to live off the income of your rentals, you’re probably not going to be able to throw additional cash toward your principal. You need that income to live off instead.
Finally, as opposed to ramping up your principal pay down, if you need to make a certain amount from your properties to use as personal income, you can do something called an interest-only mortgage. This reduces your monthly payment significantly.
Granted, an interest-only mortgage also increases the amount of your loan in the meantime. But if you bought when the market was good and the property value goes up over time, you'll be in good shape and cash flow more money in the meantime. (However, investors should obviously exercise caution, because the exact opposite situation could unfold and be financially devastating.)
For more information, watch my video above, where I go into more details about these concepts.
What questions do you have?
Let’s discuss in the comment section below.