Financial Windfall: Should You Pay Off Your Mortgage?

By Michele Lerner | Nov 13, 2014 - Realtor.com

If you have a financial windfall headed your way, whether via luck or hard work ... Congratulations!

Now that you've caught your breath, you're likely looking for the best way to manage your newfound income.

For homeowners, their biggest monthly bill is a mortgage payment. If you're carrying a large mortgage, you'll be tempted to pay down as much of your mortgage as soon as you can.

The idea of life without a monthly housing payment fuels fantasies of easy flowing cash, but before you take that step you need to consider your entire financial plan.

Pay off your mortgage, and it will make a vast difference each month—but remember you'll only eliminate the principal and interest on your loan.

You’ll still be responsible for property taxes, homeowners insurance and any homeowners association dues. In fact, those bills can increase over time, so you're not shedding housing-related fees entirely even if you're lucky enough to pay off your mortgage.

Ranking your financial priorities

While getting out of debt is a worthy goal, it’s important to establish financial security in a balanced way by increasing your savings and investments on one side and reducing your obligations on the other side.

If the financial crisis taught American consumers any lesson, it was to be prepared for a potential job loss or emergency cash crunch. Few people anticipated the depth of the economic crisis or the difficulty that many people would have finding employment.

Financial planners typically recommend that every household have at least three to six months of expenses in an accessible account. Following the multi-year recession, some experts suggested that consumers strive for as much as 12 months of expenses as an emergency fund.

The amount you keep in your emergency fund depends on many individual factors, including whether you are the sole source of income for your household, your relative job security, how difficult it would be to find another comparable job, how many dependents you have and your age. To make it simple, a young single person won't need to have as big an emergency fund as someone with a family of four to support.

That said, an emergency fund of some sort should be the number one priority for everyone. Once a minimal fund has been established, you can begin to evaluate your other priorities.

Paying off debt

If your only debt is your mortgage and you have a solid emergency fund plus a strong retirement plan, you can consider paying off your mortgage. However, consumers with large credit card debt or personal loans should pay these down first—since they have much higher interest rates and lack any tax deductibility.

On the pro side of paying off your mortgage, many people find the psychological benefit to be enormous, and they like the freedom to invest the money from their mortgage payments in other ways.

On the con side, you lose the tax deduction of your mortgage interest and have now tied up your cash in an asset that’s relatively illiquid: You can't sell a house as quickly as you can sell a mutual fund.

While you can take out a new mortgage or a home equity loan, those can take time or be difficult to qualify for if you’re unemployed or in the midst of a health crisis.

Fully funding your emergency savings account should be your first priority, but after that, work with a financial planner to determine how best to invest your extra income.

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