Those who enjoy living a frugal [life] generally try to avoid debt. Debt is bad financially, of course, because it involves paying interest, thus ensuring that whatever you’ve purchased ends up costing more in the long run than it would have if you paid the whole price upfront.
Debt can also make you feel bad knowing that if a financial emergency like a job loss occurs, you’re still on the hook for whatever you owe (plus interest).
So, if you have a mortgage or any other large debt such as a Home Equity Line of Credit (HELOC), you might be tempted to prepay the mortgage/debt in order to reduce your debt as fast as possible and save money on interest payments.
But is that always a wise financial decision?
The author of [the] My Life ROI financial blog writes in his post, “To Prepay Your Mortgage Or Not,” that it might make better sense from an economic standpoint to resist the temptation to prepay your mortgage (provided that you have a reasonable mortgage interest rate, of course).
For example, if you have the investment skills to earn 8% in the stock market, why would you want to prepay a mortgage that cost you only 5% interest? (Remember that if you itemize your tax return, you may get a deduction on home mortgage interest, too.)
So does the argument on not prepaying a mortgage hold water on close examination? Perhaps, but even the My Life ROI blogger acknowledges that completely paying off a big debt can have major psychological benefits for lots of people.
It’s also important to note that lots of people end up losing money investing in stocks, commodities and other financial interests. If you opt to play the stock market instead of paying off your mortgage and your investments go sour, you’ll still have to make your mortgage payments plus work harder to make up your losses in the market.
Ultimately, the choice depends on individual psychology and risk tolerance. If you have an iron stomach for debt, a low-interest-rate mortgage and good investment skills, opting not to pay off your mortgage early could make sense. But, for many people, the prudent, safe and frugal thing to do would be to put at least some extra cash toward paying down your mortgage early when possible.
Does prepaying a mortgage make sense to you? Or would you rather use free cash toward investments?