A home loan is perhaps the largest debt you may ever have in Arizona. Paying it off ahead of schedule can free you from the burden, save you on interest, and help you attain full ownership of your house sooner.
Any mortgage company in Tempe or Phoenix knows that you can accelerate the repayment of your home loan in several ways.
First, you can pay a sizeable down payment, which incidentally reduces your interest over the life of your mortgage and may eliminate private mortgage insurance. Second, you can get a short term and pay down your loan more quickly. Third, you can make extra payments to decrease your principal fast; you may incur a penalty for finishing your mortgage repayment early, but your savings in interest may exceed it.
Despite the clear benefits of paying off your home loan ahead of time, there are disadvantages to it, too. Learn about the most notable ones below:
The Rate of Return Is Low
The more money you put down, the lower the rate of return you get. If your property price increases 6% every year, a house worth $450,000 becomes $477,000 after 12 months. No matter how much you paid upfront, the value of your property is the same.
However, your wealth grows at a slower pace if you pay a large down payment. If you put down 20%, or $90,000, your rate of return is only 30%. But if you pay 5% initially, or $22,500, your rate of return is 120%.
However, this strategy is not without risks. You can get a lot of rate of return only when the land appreciation in your area is fast. If the local real estate market goes cold, you may even get negative equity on your property when you do not cover a big portion of your property price when you make the purchase.
The Cash Will Be Tied to Your House
Speaking of equity, this type of wealth is illiquid. In other words, it is not easy to convert into cash, which is something you can spend on everyday goods and services.
Paying more than what you owe on your mortgage every month can effectively reduce your principal ahead of the amortization schedule, but it can also make you cash poor.
There are only two ways to tap the home equity you built on your house over time: borrow against your property again or sell it. Either way, you will enjoy the maximum growth of your home equity because the former involves paying interest while the latter comes with a capital gains tax.
Investment Diversification Can Be an Opportunity Cost
Choosing to put your money in real estate means deciding not to put it elsewhere. You may miss out on other investment opportunities, which can diversify your portfolio and help protect your wealth from uncontrollable and volatile market forces. It is wise not to put all of your eggs in one basket to enjoy a financial cushion against adverse economic events.
Paying off your mortgage early always comes with benefits and risks. Since you can’t get the good without the bad, think critically to make a decision that you will not regret.
