Ask an advisor: Are extra mortgage payments a good idea?

April 4, 2023 5:41 PM

Some homeowners have the option to make additional payments toward their mortgages, but not all wealth managers recommend it.

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

Real estate is an important part of how Americans build their wealth. In the final quarter of 2022, 65.9% of American household owned their own homes, according to the U.S. Census — up from 63.7% at the end of 2016. And they believe it's a good investment. In a survey conducted by CNBC and the research firm Momentive, 23% of respondents said buying real estate was the best way to grow their personal wealth — more than any other financial decision.

But buying a home is expensive, especially these days. As the Federal Reserve raises interest rates to battle inflation, mortgages have skyrocketed. In October last year, the average 30-year, fixed-rate mortgage reached 7.08% — its highest point in two decades, according to Freddie Mac. (As of late March, the average has come down to a still-expensive 6.32%.)

To make mortgages more manageable, some banks offer the option to make additional, principal-only payments — what's sometimes called "pre-paying your mortgage."

For a homebuyer who can afford it, paying off more of the loan upfront could mean spending less on interest over the long run. As Chase Bank puts it, "Making additional payments may save you money by decreasing the total amount of interest you pay over the life of your home loan."

But whether this option makes sense depends on the loan and depends on the borrower. One homeowner in New York is pondering this very question and submitted it to our readers for their advice. Here's what he wrote:

Dear advisors,

Is it always a good idea to make additional payments toward your mortgage? What are the pros and cons of doing so?

For context, I'm a 28-year-old lawyer in Westchester, New York. Together, my wife and I make a combined $220,000 per year. We own a four-bedroom house here in Westchester, which we bought for $650,000. We have a 30-year mortgage, and every month we pay $1,500 (including interest, which for us is 3.25%).

Would it be worth it for us to put down additional, principal-only payments to speed up the mortgage and pay less interest over the long term? I've heard some mixed reviews about this option, so I'd like to get some clarity as to why we should or shouldn't do this. Please advise!

Thanks,

— Wondering in Westchester

And here's what financial advisors wrote back:

Don't do it

Jeremy Eppley, an accredited investment fiduciary and the founder of

Silverstone Financial

in Owings Mills, Maryland

In today's high-interest-rate environment, you should not pay down your 3.25% mortgage. You won't get a loan anywhere close to that rate today! Hold onto it.

If you want guaranteed, insured returns instead of the stock market or other investments, many high-yield savings accounts are paying more than your mortgage charges. Ally currently pays 3.75% on savings, so you should definitely not make extra payments on your mortgage. Instead, simply put that money in a guaranteed-return 3.75% savings account — that is a 0.5% better return.

Even if you are worried about how interest rate changes could affect this plan, don't. Your mortgage rate is fixed; it won't change. If your savings account rate changes in the future and falls below 3.25%, you can always use those savings to pay down the mortgage balance in one lump sum.

Bottom line: You are better off investing your cash flow somewhere else (don't spend it!), instead of paying down your mortgage.

Go for it

Tom Balcom, a certified financial planner and the founder of

1650 Wealth Management

in Lauderdale-By-The-Sea, Florida

Yes! I am a big proponent of paying down debt, whether it's a mortgage, a student loan, etc. The peace of mind that comes from paying off a mortgage cannot be measured purely in financial terms. Also, not having a mortgage improves one's credit score as well. While some folks may say that your borrowing cost may be in the 2% range due to the tax write-off, all of my clients list peace of mind being a huge factor in paying off their mortgages.

Keep inflation in mind

Lindsey Young, an investment advisor representative and the founder of

Quiet Wealth

in Baltimore, Maryland

From a purely economic perspective, it is generally a poor choice to make additional principal payments on low-interest, fixed-rate mortgages during inflationary periods like today. The math is simple: You can earn 4.5%-5.0% in a high-yield savings account while paying 3.25% through the mortgage.

As long as itemized deductions and the mortgage interest deduction are being taken, it would be uneconomic to pay down additional mortgage principal. If the household is taking a standard deduction, then it may be closer to a break-even economic choice for households in higher tax brackets.

But more broadly, a low-interest, fixed-rate mortgage provides great financial planning value to households as an effective inflation hedge. Families with a low-interest rate mortgage will generally benefit from an inflationary environment because the percentage of the household's income going to the mortgage is likely to decrease more quickly with higher inflation, assuming wages are at least rising in line with inflation.

This reduction in the percentage of income going to the mortgage provides a cushion as other costs rise. Because of this inflationary hedge value, I generally recommend against households paying down their low-interest-rate mortgages.

Tackle your other debts first

Nadine Marie Burns, a certified financial planner and the CEO of

A New Path Financial

in Ann Arbor, Michigan

I would look at many things in context of this question. First of all, do you have any other debts — credit cards, auto loans, student loans? If so, I would pay those first before paying extra on the house. Cars depreciate, so having a loan on them with interest is a double negative to your net worth. Credit card debt is usually at a higher interest rate, and if you signed up for student loans, pay them down as you promised you would.

Then make sure you are putting at least 10% in your retirement savings plan at work. The goal is to reach 15% plus any match. Only after all non-housing debts are paid and you are between 10%-15% in retirement savings (and you are saving in a 529 for your children's education) is it time to throw extra at the house.

It depends

Jennifer Marx, a financial advisor and the founder of

Partner Financial Planning

in Lakewood, Colorado

The answer to the question, "Is it always a good idea to make additional payments towards your mortgage?" is simply "no." However, the real question is, "Does making additional payments towards your mortgage make sense for you?" For that, the answer is "it depends."

From a purely financial perspective, a mortgage at 3.25% interest in this market is a steal. You would earn more interest on your dollars in a high-yield savings account than you would save by paying down your mortgage. Of course, there is also more return potential in the markets (which come with more risk). Not to mention, if you are itemizing your deductions on your taxes, that interest is also saving you some tax dollars.

All that said, personal finance is personal. Do you sleep better at night with less mortgage debt? Do you simply enjoy owning your home outright? Do you want to feel insulated against home value swings? All of these are perfectly credible reasons, as the goal should always be to match the use of your finances with your personal preferences and goals.