Today we are going to look at if it is a good idea to overpay and close your home loan/mortgage early. We also see the benefits or paying earlier and the possible conditions under which you should not pay your home loan early.
No topic has been more hotly debated in the personal finance blogosphere than the question of should you overpay your home loan or keep it running for as long as possible.
Being mortgage free much before the planned end date is awesome. It would be pretty amazing and surely the right thing to do, wouldn’t it?
However, a lot of other people wouldn’t agree. People say that interest rates have never been so low and because of the rate of inflation, banks are basically giving out almost free money and the best thing to do is invest your money into the stock market or other investment options as you will get a better rate of return.
Overpaying loan depends on your situation
Not everyone have the same set of variables. It is a given that you need to pay the amount due for your loan. But, whether you can pay more depends on how much you earn, your spouse earning, your age, time left to retire, earning potential from other sources, the amount of interest you are paying etc.
And most importantly, geography too matters as taxation of mortgages vary by country.
Home Loans: Tax benefit matters
First and foremost, if you are someone in a country that provides tax relief to a home mortgage, then a loan ma be good. Example, paying off a loan in India, it is not the same as others who wish to pay off a mortgage somewhere else. The reason being, in India, you get an incentive to keep your mortgage open! Tax break 😉. Yes, you would enjoy a good sizable tax break for paying off a home loan, for both the principle and the interest.
As such the motive for you to overpay your loan will depend on multiple criteria such as:
- Current interest rate
- Tax break/incentive to pay loan
- Earning potential from investments
Let’s look at these in detail.
Paying down our mortgage may give you a higher rate of return than other risk-free savings or investments. Here are some reasons why you can think of over paying your home loan.
Take my case for example, I am paying a home loan at an interest rate of 8.1% pa. It is a lot more than the returns I get from Fixed deposits or other risk-free investment sources.
Yes, we could get a higher rate of return but that would involve us taking a risk. Maxing out our mortgage so we can invest in the stock market could potentially give us huge rewards but could also give us huge losses as well. Some people are prepared to take this risk depending on their risk appetite.
Saving money with lesser interest
Another huge advantage to overpaying mortgage is the amount of money you save on paying interest. Plugging the figures into a mortgage calculator will show you that you could easily reduce several lakhs by paying more per month. That is a lot of money!
What if you take the money saved in interest and invested it every year in to an ETF with an average yield of 6% and re-invested the dividends?
By paying off more than the amount due, you will pay off your mortgage early and a nice stash of cash!
This may seem daft, but every time you make an overpayment, there is a little rush of excitement. A short term little buzz that feels like you are showing the finger to the bank you took the loan from.
Long term, you get a feeling of empowerment. Knowing that you no longer need to be a slave to the bank and hand over your hard earned money every month just so they can have their big fat bonuses.
To some people there is something called a good debt and bad debt. To some people, debt is……… a debt. Any good debt can quickly turn to bad debt if you lose your job and can’t afford the monthly repayments. So to these guys, paying of extra on the loan has immense psychological benefits.
Paying off the mortgage has a huge emotional effect on one’s family life. Knowing, soon, you own the lump of bricks we call home and not having to be so worried about job loss has an enormous positive impact on your emotional well being, giving you peace of mind.
Possible reasons for not overpaying a mortgage
Like mentioned earlier, these reasons vary based on your situation.
A good chunk of your investment will be in real estate depending on your portfolio, this may be a bad thing.
Basically, you are putting the majority of your eggs in one basket. Once your mortgage is paid off, the majority of your net worth will be tied up in the property. Since you use this property as a home, you may not be able to produce an income from it.
Tying up your whole net worth in property is dangerous because when you need quick access to cash, its all tied up in bricks and mortar and the only way to release funds is to sell up or go and re-mortgage but none of these ways are cheap and certainly not quick.
Cost of opportunity lost
Then there is the lost opportunity in the income you could have generated had the extra money you paid for the loan been invested elsewhere. This depending on your situation and investing acumen may be a sizeable amount. If you are confidently able to generate 12% or more from stock investments, then a 8% mortgage loan will lead to you losing out on 4% profits.
If your country gives you taxation benefits and tax breaks on your home loan, then you lose out on that. In India, you get a sizable tax break up to 30% (depending on your tax bracket) on upto Rs.3,50,000 of the loan you pay. If you are paying around that much, like me, then that 30% is a big amount. One may chose to willingly pay the mortgage simply to enjoy this tax break.
It all boils down to what is your situation, priorities and outlook in life. You may want to end up with more money in your pocket if the extra amount is invested while paying off your mortgage as slowly as possible. Or you may be someone who likes to have that feeling of security, which beats possible stock market returns.
There is no right or wrong answer to the questions of “Should I pay extra towards my home loan?”. Simply analyze, weigh the pros and cons in your current situation and make a decision. It is your personal choice. What matters more is that you take an informed decision and either overpay your mortgage or invest the excess money.