In Paying Off Your Mortgage – Part 1, we talked about the pros and cons of paying off your mortgage. As part of the decision making process, you should also know how paying off your mortgage impacts your debt, taxes, budget, credit score, and home equity. Let’s look at some of these impacts:
How paying off your mortgage impacts your debt
- Paying off your mortgage means you no longer carry a monthly mortgage expense and can now use that money to invest in other assets, reduce other household debt, or use for other monthly expenses.
- If your mortgage is your only loan, and you have no other positive payment history (i.e., no credit cards, no other loan payments), you may have trouble re-establishing credit after paying off the mortgage. Or, you may pay higher rates for a future loan than you would have had to pay otherwise.
How paying off your mortgage impacts your taxes
- The interest paid on your mortgage is sometimes the biggest itemized deduction for taxpayers. Once the mortgage is paid off, you will no longer have a deduction for the mortgage interest on your itemized deductions. Loss of this deduction may increase tax liability.
How paying off your mortgage impacts your budget
- Making extra principal payments on your mortgage increases the percentage of your monthly cash flow that is used for debt payment. A traditional rule-of-thumb that lenders use when approving loans is that housing payments should not exceed 28% of monthly gross income and combined debt payments (mortgage, credit cards, student loans, etc.) should not exceed 36% of monthly gross income.
- Reducing contributions to other goals (college savings, retirement) in order to pay down your mortgage may not be in your best interest in the long-term.
How paying off your mortgage impacts your credit score
- The largest factor that is considered in your credit score is your positive payment history. Taking out a mortgage can have a positive impact on your credit score for two reasons: it builds up your mix of credit on your record and it allows you to build a positive payment history.
- Mortgages and other installment loans (such as credit cards, car loans, or student loans) can help improve your creditworthiness as long as you continue to make your payments on time.
- Paying off a mortgage usually does not have much of an impact on your credit score.
- There’s a chance that if your mortgage is your only installment loan, paying it off could have a slightly negative impact on your credit score, but the impact would likely be minor because of your positive payment history (assuming you have a positive payment history).
How paying off your mortgage impacts your home equity
- Home equity is the current market value of the home minus debt.
- Home equity increases as mortgage payments are made against the principal balance and/or the market value of the home increases.
In Paying Off Your Mortgage – Part 3, we summarize some important questions to ask before paying off your mortgage as well as provide 3 strategies for accelerating your payments.
Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.