As someone who is debt free in all other aspects of my life, it’s probably not surprising that I prepay my mortgage. By prepaying, I mean paying more than the required payment each month. This will allow me to pay off my mortgage in about a third of the time. I’ll save a ton on interest and it seems like good financial sense, but there are some opposing views to consider. The fact that opinions vary so widely on the subject is a good indication that the right answer is highly dependent on your personal situation. Statements like “prepay 10% extra each month and you’ll be in a great position” are of no real value to anyone. There are simply too many other factors: Are you maxing out your retirement before considering prepay? How long do you expect to live in your house? What’s the real estate market like in your area? The list goes on and on. Instead of trying to give a one size fits all solution, I thought I’d discuss some of the different points of view and let you come to your own conclusion.

Typically, the first argument against prepaying your mortgage is that you can invest your money elsewhere for a higher return. Mortgage interest rates have been at historic lows for the last few years. If I was paying a rate closer to credit card rates, which wasn’t uncommon as recently as about 10 years ago, then paying off my mortgage would probably be a good decision. The fact that my mortgage is at a fixed rate below 6%, makes the decision much more difficult. The reason is that finding an investment to beat a 6% return is possible, if not easy, to do. If I could earn more on an investment than I pay in interest on my mortgage, then from a financial perspective, investing would make more sense. If I had other debt, then this point would be made even stronger. Prepaying my mortgage at 6% while running a balance on my credit card or taking on a car loan, would be a stupid thing to do. When comparing two investment alternatives, remember that taxes come into play as well. Mortgage interest is tax deductible (which reduces the cost of your interest, but more on that later) and alternative investments likely have gains which are taxed as well.

The counter-point to the “better gains elsewhere” argument is that prepaying your mortgage is a guaranteed return. Unlike most investments, you can calculate exactly what the return on prepaying your mortgage will be. Alternative investments tend to fall into two categories: those with low but known returns and those with potentially higher but unknown returns. Returns follow the classic risk versus reward rule. Part of the guarantee of the return on prepaying your mortgage is the fact that you get to live in your investment. I don’t agree with a lot of Suze Orman’s philosophies, which tend to be too generalized for my liking, but her quote that “You cannot live in a stock certificate. You live in your home.” is certainly on point.

Prepaying when you have extra money doesn’t help you when you do not. Until your mortgage is completely paid off, you still have to pay each month. So even if you prepay for years, you generally can’t skip payments in future months. If your finances take a hit from a lost job, injury, or similar, all of your prepayments aren’t going to help you come the first of the month.

The previous point is a derivative of the fact that real estate is not a liquid investment. Depending on where you live, it may be difficult to get the equity that you’ve build through prepayments out of your house. Even if you can sell your home easily and at a good price, the process still takes time. Borrowing against your equity with a HELOC or 2nd mortgage is a faster way to get money out of your house, but puts you back in the debt you were trying to avoid. Also, the current housing crunch reminds us that prices do fall sometimes. Counting on home equity can be risky if your house isn’t worth as much as you hope when you need the money.

A terrible argument that I often hear for not prepaying your mortgage is that mortgage interest is tax deductible. The argument is that having a large mortgage and paying a lot of interest means you save a lot in taxes. People who make this argument don’t understand what a tax deduction is. I wrote a separate post on this topic, but will try to summarize it in one or two sentences here. The mortgage interest deduction reduces your taxes by a a portion of what you paid in interest. So for every dollar you pay, they give you back 28 cents (assuming you’re in the 28% tax bracket). Only a fool can believe that paying a dollar to save 28 cents is a good idea.

If you decide that prepaying is right for you, make sure that there is no penalty to do so. Many loans, particularly those with conventional terms, have no penalty, but it’s best to check first. Also, make your prepayments by simply writing a larger check each month. Some companies offer formal prepayment or bi-weekly plans that you have to pay extra for. If you’re eligible to prepay without a penalty, then you should do so without joining a paid service. Just make sure that it’s clear that your extra payment is to be applied to principal as opposed to being an early payment for the following month.

The amount to prepay is also highly dependent on your situation. A common practice is to pay 1/12 extra each month and after a year you’ll have made 13 payments versus only 12. I prefer to make much higher payments each month, while I’m able to do so, with the goal of having my mortgage paid off very quickly. To me, prepaying my mortgage is just one part of my overall financial and investment plan. I consider it part of my diversification strategy. My mortgage isn’t the first or the last place I invest, but it always gets a share of my monthly discretionary spending.

There is the psychological benefit of paying off your mortgage, but that is hard to quantify. Would you be happier with no mortgage but having missed out on a fantastic alternate investment? Would you feel bad that you hadn’t prepaid your mortgage but made a killing in the stock market instead? With hindsight, the worth of many financial decision become much more clear. In the here and now, the best we can do is educate ourselves, apply that knowledge to our specific situation, and make the most informed decision possible.

This post is included in Money Hacks Carnival #3, hosted at My Dollar Plan.