For some people, getting rid of their mortgage is their top priority. After all, it’s by far the largest personal debt one is likely to ever owe, and having no mortgage will free up a nice chunk of that monthly income. That’s why we don’t just pay it off, we burn the mortgage paperwork when it’s paid off.
Is it in your best interest to take your extra money or use it to pay the mortgage off early? This isn’t such a clear cut issue, let explore what might impact your decision.
First, and most important, are you taking advantage of any matched 401(k) your employer may offer? A dollar for dollar match should be grabbed regardless of the rest of your situation. Even ahead of paying off any other debt. Companies usually limit the match to 5-10% of the employees’ gross income, so if you make $50,000, the first $2500-$3000 is matched, and that’s it. Don’t miss this.
Do you have any revolving debt? Credit cards? Store cards? Common sense tells you it’s silly to pay 12-18% interest on this debt, yet make extra payment on a 6% mortgage.
Do you have a proper emergency fund? The real concern at the bottom of this question is can you survive the loss of your job and still keep your home until you find new work? Remember, when you send extra money to your mortgage, it’s a one-way street, you can’t easily borrow it back. Of course you can arrange for a HELOC (home equity line of credit) but not after you are out of work. I view the HELOC as a bit of a slippery slope. It can be responsibly used as a secondary emergency account, but should not be your only source of funds to cover unexpected expenses. Your hot water heater fails, you should be able to pay for it.
In the final analysis, it comes down to one question – Do you feel lucky, punk? I ask this in all sincerity, as in most situations it will requite luck to choose the best outcome. We can look at all the data we wish, time periods when stocks returned over 19% on average (the ’90s) or a decade of less than 1% growth per year (the recent ’00s). You can play with the numbers all you wish, but unless Treasuries are yielding more than your mortgage (adjusted for tax implications) then Dirty Harry’s question will come back to haunt us.
Consider, in the big picture there is little difference between a dollar used to pay down a 5% mortgage or one sitting in a 5% CD. Of course, the big difference is liquidity, but I am talking instead about the return on your money. So, as you get older and look at your portfolio, when you look at your stocks and cash allocation, it may make sense to accelerate those mortgage payments and enjoy the savings of 5-6% vs the 1% you might currently get in CDs. For our situation, we decided that it was wise to refinance in 2004 to a 15 yr, aligning our mortgage payoff more closely to when our daughter would start college.
In the end, you might read some very insightful analysis showing that 5% after taxes is really 3.75% if you are in the 25% bracket, and if cap gain rates stay at 15% (they might) that a fund yielding 4.4% will break even. DVY (The Dow Dividend stock ETF) yields 3.6%, the underlying stock need to grow just 8% over the next decade to let you break even. This is total growth, not each year. But the question remains, are you willing to bet on the markets return over the next ten years? Do you feel lucky?
This was a Money Maven Network wide posting, my fellow mavens discussed this topic as well:
Green Panda Treehouse – Pay Off Your Mortgage or Invest Your Money?
Wealth Pilgrim – Pay Off Your Mortgage or Invest
Money Help for Christians’ Pay Off Mortgage Sooner, Invest, Or Save? The Math Analysis
Len Penzo – 12 Good Reasons Why You Should and Should not Pay Off Your Mortgage Early
Enemy of Debt – Should You Grow Your Nest Egg Or Pay Off Your Mortgage?