Think of your home loan like a big puzzle. Many people rush to pay it off fast, but that might not be your best move. Let's say you have an extra $500 each month. You could use it to pay off your house. Or, you could put that money into the stock market. Over 30 years, that money could grow into more than $1 million!
Your home loan costs you less than you think. Most loans only charge 3-6% each year. Plus, you can get money back on your taxes when you pay your loan. As time goes by, your monthly payment stays the same, but it feels smaller because money is worth less over time. Your house also goes up in value.
Smart money people often keep their home loans and put extra money into things that grow faster. When you look at the math, keeping your loan might help you end up with more money.
The Opportunity Cost Factor
Money Choices Matter
When you have extra money, you need to think about what to do with it. You can pay off your home loan faster or put that money to work in other ways.
Let's say you pay off your home loan early. This means you pay less in loan costs. But you could miss out on making more money if you put that cash somewhere else.
Think of it like this: You have $20,000 to spare. If you use it to pay off your home loan, you save $700 each year. But if you put that money in things like stocks, you could make $1,600 each year instead. That's $900 more in your pocket!
Smart money people often keep their home loans and put extra cash into things that can grow more. This way, their money works harder for them.
Tax Benefits of Mortgage Debt
Getting tax money back from your home loan is a great way to save money. When you pay your home loan each month, you pay interest. The tax people let you pay less taxes if you list this interest on your tax forms.
But this only helps if all your special tax items add up to more than $13,850 if you're single, or $27,700 if you're married. To get the most money back, keep track of what you pay in home loan interest.
Also add up other things like house taxes and gifts to charity. If these add up to more than the basic amount, you can save big on your taxes.
Mortgage Interest Tax Deductions
Owning a home can help you save money on taxes through something called the mortgage interest deduction. This tax break isn't as big as it used to be since the tax law changed in 2017. Now, many people take the basic tax break instead.
Want to get this tax break? Keep these simple facts in mind:
- You can only claim tax breaks on home loans up to $750,000 if you bought your home after December 15, 2017.
- This break only helps if your total tax write-offs are more than $13,850 if you're single, or $27,700 if you're married (in 2023).
- You need a form called 1098 from your bank to claim this break.
- People who make lots of money and live in pricey homes get the most help.
- You save the most money in your first year, then less each year as you pay off your loan.
Impact On Itemized Deductions
Your taxes get simpler when you pay off your home. In 2023, you can take a basic tax break of $13,850 if you're single. If you're married, it's $27,700.
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When you have a home loan, you pay the bank interest. You can deduct this interest on your taxes. But as you pay off more of your loan, you pay less interest. This means you might get a smaller tax break.
Let's say you pay less than $8,000 in loan interest each year. Add in your other tax breaks, like property taxes and gifts to charity. If the total is less than the basic tax break, you mightn't get extra money back for your home loan.
Many people find this happens near the end of their loan.
Maximizing Annual Tax Savings
Let's make your tax savings grow bigger this year! You can save money just like a kid saves coins in a piggy bank.
Paying for your home can help cut your taxes. Here's how:
- Pay two years of house taxes at once. This helps you save more than if you split them up.
- Make your January house payment early in December. This lets you save more on this year's taxes.
- Keep good notes when you change your home loan. The fees you pay can save you money for many years.
- If you'll make more money this year, keep a bigger home loan. This helps lower your taxes when you need it most.
- When you give to good causes, do it in the same year you make big house payments. This can help you save more than $12,950 if you're single or $25,900 if you're married.
Remember: Saving on taxes is like finding extra money in your pocket – it feels great!
Investment Returns Vs Mortgage Interest
Think about your house payment and putting money in the stock market.
The stock market can make you more money over time – about 10 cents for every dollar you put in. Your house loan might only cost you 3 to 6 cents per dollar.
But here's the thing: paying off your house is a sure bet. The stock market goes up and down. You can get your money out of stocks fast if you need it. Getting money from your house is harder.
Look at what makes you feel good. Some people like the safe feeling of paying off their house. Others are OK with taking a chance to make more money in stocks.
Market Returns Beat Mortgages
Putting extra money in stocks instead of paying off your house early could help you earn more over time. Most homes today have low interest rates around 3-4%, while the stock market tends to grow about 10% each year.
Let's look at what stocks have done:
- Since 1926, stocks have grown about 10% each year
- Even when prices go up, stocks still grow about 7%
- Spreading your money across different investments works better than just one
- Home loans have stayed under 5% for the last ten years
- Money in stocks can grow faster than saving on house payments
If you have spare cash, putting it in different types of stocks and bonds might help you save more money than paying off your house faster.
Your money has a better chance to grow bigger this way.
Lost Investment Opportunities
Think of your mortgage like a piggy bank. When you put extra money toward your 4% loan, you save a little on interest. But that money could work harder for you in other places.
The stock market tends to grow your money faster than paying off your house early. Over many years, stocks have grown about 10% each year on average. That's much better than the 4% you save on your home loan.
Let's look at what this means with real money. Say you have an extra $500 each month. You have two choices:
Choice 1: Put it in your mortgage
You save $320,000 over time.
Choice 2: Put it in stocks
Your money grows to $1.1 million over 30 years.
The difference is big – $780,000 more if you pick stocks instead of paying extra on your house. This is why it's smart to think hard about where your extra money should go.
Risk-Adjusted Return Comparison
Think of your money like two paths. One path is paying off your house loan early. The other path is putting money in stocks.
Stocks can make more money, but they go up and down a lot. Some years you win big. Other years you lose money. It's like riding a roller coaster.
Paying off your house loan is more like walking on flat ground. You know exactly what you'll save. If your loan costs 4% each year, that's what you'll save. No surprises.
When picking your path, think about:
- How safe you want your money to be
- How long you plan to save
- What you pay in taxes
- How you feel when money goes up and down
Both paths can work. The safe path means less worry. The rocky path might mean more money, but also more stress.
Pick the path that helps you sleep at night. Some people like the steady walk. Others don't mind the roller coaster ride.
Emergency Fund Priority
Think of your emergency money like a safety blanket. You need this money ready before you try to pay off your house early.
Keep enough money to pay your bills for 3-6 months. Put this cash where you can get it fast.
Here's why this matters: If you spend all your extra money on your house and then lose your job, you'll be stuck.
Even if your house is worth a lot, you can't use that money to buy food or pay bills unless you sell it. That's not good!
Keep your emergency money in a bank account that gives you good interest. Your money can grow there, and you can still get it when you need it.
Current Interest Rate Environment
Money Smart: What To Do After Your Safety Net
Now that you have saved your rainy day money, let's talk about loans and how much they cost today. The price of loans affects what you should do with your home payment.
Look at these money facts:
- Most people paid about 6.5% on home loans over the last 30 years
- Today, new home loans cost about 7%
- Bank savings can earn you 4-5% each year
- Safe bonds can earn you 5-6% each year
- Stocks often earn about 10% each year
If your home loan costs more than what you could earn by saving or investing, pay extra on your loan.
But if your loan costs less than 5%, you might want to put extra money in savings or stocks instead.
This way, your money works harder for you.
Mortgage as an Inflation Hedge
Think of your mortgage like a shield against rising prices. When you get a fixed-rate loan, you pay the same amount each month.
But as time goes by, prices go up and people earn more money. Your $2,000 house payment stays the same, even as milk, gas, and other things cost more.
After 10 years, that $2,000 will feel smaller, like paying $1,485 in today's money. As prices rise, your loan gets easier to pay off.
And best of all, your house will likely be worth more too!
Fixed Payments, Rising Prices
When prices go up, having a fixed home loan can help you save money. Your monthly payment stays the same even as things get more costly. This is good for you!
Think about how this helps you:
- A $2,000 payment now will feel smaller in 10 years
- Your job pay usually goes up as prices rise
- Rent costs go up, but your home payment stays the same
- The money you owe becomes easier to pay back
- You pay back your loan with money that's worth less than when you first got it
This is why many money helpers say it's smart to keep your home loan when prices are going up.
Even if you can pay it off, you might want to keep it.
Debt Gets Cheaper Over-time
Money you borrow today gets easier to pay back over time.
Let's say you take out a big loan of $300,000 for a house. Each month, you pay $2,000. As time goes by, that $2,000 doesn't feel as big because money loses some of its power to buy things. After 10 years, that same $2,000 payment will feel more like $1,485.
Think of it this way: Your house payment stays the same every month, but you'll likely get pay raises at work. If you make $75,000 now, you might make $100,000 in 10 years.
This means your house payment will take up less of your money each month. It's like paying old bills with new money that doesn't buy as much. This actually helps you save money in the long run.
Retirement Account Considerations
Think about your retirement money before paying off your house early.
Put money in your retirement accounts first. This helps you save on taxes and grow your money faster.
When your boss matches your 401(k) money, you get free cash. For every dollar you save, they might give you 50 cents or even a dollar more.
Your retirement accounts can help you:
- Pay less in taxes now
- Grow your money without taxes
- Save more over time
- Get free money from your boss
Time is your friend with retirement savings. The money you put in grows year after year.
Most people earn about 7% each year in their retirement accounts. This is better than saving 3-4% by paying off your house early.
You can only put in so much money each year to retirement accounts. If you skip a year, you can't make it up later.
This is why saving for retirement should come first.
Housing Market Dynamics
Your house is like a piggy bank that changes in size. Most years, it grows a little bigger on its own – about the same as three shiny quarters in a $10 jar. This happens even if you just make your normal house payments.
But sometimes, the housing piggy bank can shrink. It doesn't matter how much money you put in it. Bad times can make your house worth less, just like what happened to many of your neighbors.
Think about keeping some of your money in your own bank instead of putting it all in your house. Some people who put all their cash into their homes had a hard time when houses lost a lot of value. They wished they'd kept more money in their pocket for tough times.
Your house's worth depends on many things: how many jobs are in town, what's being built nearby, and what other houses cost.
It's smart to think about all of this before you rush to pay off your house early.
Financial Flexibility Matters
Money gives you choices – keep it smart and simple!
Don't put all your money into your house payment. Spread it around to help it grow and be ready for surprises.
Here's what to do with your money:
- Save enough to live for 3-6 months
- Put some money away for when you're old
- Put your money in different places, like stocks and bonds
- Keep a bit of money ready for good deals
- Save a little each year to fix your house
Think about what your money can do for you. If you pay 4% on your house loan, but can make 7-10% by putting that money in stocks, you might want to invest it instead.
When life throws you a curve ball or you see a chance to make more money, you'll be glad you kept some cash free.
Risk Management Strategies
Money helps you live better, but you need to protect it too. First, save enough money to pay your bills for 3-6 months. Keep this money in a bank where you can get it fast. Most people in America spend all they earn each month. This makes it hard when they've money problems.
Your house is worth money, but you can't use that money easily when you need it fast. If you pay too much on your house but then lose your job, you mightn't be able to get a loan.
A better plan is to split your extra money three ways:
- Put 25% toward your house payment
- Save 25% for hard times
- Put 50% in places where it can grow
This way, your money is in different places. If one thing goes wrong, you still have other ways to get help.
