Over the years I have addressed the issue of whether or not to pay off your mortgage early numerous times. It seems the decision to do so, not to not do so, is very much like most financial decisions – it’s personal.
Sure, there are a few mathematical advantages to doing it one way or the other. And yes, those advantages may be magnified depending on your current mortgage’s interest rate. However, if you leave math out of the equation (not easy), the decision to put extra money towards a mortgage is largely an emotional decision.
More Cash or a Paid-for Home?
Imagine you had a savings account with the exact balance of your mortgage. The savings account earned 1% interest (I know I said to leave math out of it, but we’ll get to that), and your mortgage rate is 5%. Would you write a check and be mortgage-debt free, and cash poor?
My guess is you would not. I tend to agree. Again, there are mathematical advantages to paying off your morgage early. In our scenario, you are essentially paying 4 more percentage points than you are earning every year for the right to continue to borrow money from the bank to live in your home.
But by writing a check to pay off your mortgage you have essentially wiped out all of your cash. What will you do when the hot water heater breaks, or someone gets sick, or you lose your job (trust me, one of these things will likely happen if you spend 100% of your cash). Yes, there are credit cards and home equity lines (maybe) to finance smaller emergencies, but when this happens you will sure miss that cash reserve.
The Mortgage Sinking Fund Concept
Being the overly conservative person I am, unwilling to take huge risks and being quite content with a healthy emergency fund, I would probably opt to create a sort of mortgage sinking fund.
I would essentially have my mortgage payments withdrawn from that large savings account each month. I would continue to put a little extra towards the principal balance as my monthly cash flow allowed. And I would continue to build savings in other areas – a dedicated emergency fund, investments, retirement, etc.
When my other savings were sufficiently in place to handle emergencies, and my mortgage balance had been whittled down a bit through a few extra payments, then I might be comfortable writing a single check.
The main advantage to this plan is that I get to hang onto my cash reserve for a rainy day (and I mean, really pouring). I think that is a good idea with economic uncertainty becoming the new normal and probably continuing for the foreseeable future.