Special Report

Five Common Mistakes People Make Paying Off Their Mortgage

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Total mortgage debt in the U.S. reached $11.18 trillion at the end of March, according to the Federal Reserve Bank of New York. Mortgage debt accounts for 71% of all household debt – the highest in decade. Many homeowners dream about paying off their mortgage early for peace of mind. (See the most popular cities for homebuyers.)

Though generally paying can be a wise financial decision, it can also carry several risks. 24/7 Wall St. created this list of five common mistakes made when paying off a mortgage early based on a report produced by financial technology company SmartAsset, entitled 5 Mistakes to Avoid When Paying Off Your Mortgage Early.

It is understandable you want to wipe the slate clean and have one less debt to pay each month. Yet you could leave yourself cash strapped if you plow too much money into paying down your mortgage. Instead of using any extra cash to pay down the mortgage, you can put it to better use elsewhere, like the stock market, where you could earn higher returns. Also, once you pay off your mortgage, you are no longer eligible for a federal mortgage interest rate deduction at tax time.

Whether you pay down your mortgage before the end of the term is a personal decision. Not having mortgage payments every month lifts a huge burden. Just beware that doing so could cost you if you do not consider all your options and possible pitfalls. Looking for more cash? Try one of these 28 ways to make extra money.

Click here to see five common mistakes people make when paying off their mortgage.

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1. Not considering all of your options

If you have extra cash to spare, you may be tempted to put that money toward your mortgage and get out sooner. But doing so may not be the best use of the funds. Investing the money into stocks could be a better bet. Over the past 90 years, the S&P 500 has had an annualized return of 10%, a better return than any savings on interest payments.

For instance, say you plan to reduce the mortgage principal by $20,000. On a $200,000 loan, you could shave off $8,300 in interest and pay down the mortgage two-and-a-half years sooner. If you put that same $20,000 in an index fund with an annual rate of return of 9.8%, you could earn $30,900 in interest over 10 years.

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2. Skipping extra payments towards the loan principal

You are charged interest based on the principal. So paying down your principal can cut your interest payments. Unfortunately, that only works if your lender knows if the extra money you are paying goes toward the principal. Otherwise, the extra money could be used to reduce the interest payment. Specify to your mortgage provider you want the added dollars to go toward the principal.

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3. Forgetting to check if there’s a prepayment penalty

Lenders make money on interest payments, and if you pay your mortgage off early, they will lose money. Bankers are not too happy about that prospect, so they may penalize you. Check to see if you will be charged a prepayment penalty before paying off your mortgage in advance. For example, a 3% prepayment charge on a $250,000 mortgage could cost you $7,500.

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4. Failing to have a rainy day fund

The thought of taking one more debt off the table is tantalizing. On the other hand, if you deplete your savings and have no rainy day funds for emergencies, you may regret it.

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5. Extending your loan term while refinancing

Refinancing your mortgage can result in savings. If you are thinking of refinancing, consider converting to a shorter rather than the same or longer terms. By converting to a shorter term, you will lower your interest rate and get out from under the mortgage sooner — which is your ultimate goal. Watch out for the closing costs on the refinance. If your lender rolls those fees into the new loan, you could end up with a larger loan amount.

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