| Owning a home outright is a dream that many | | | | more money toward your mortgage. Will you have the |
| Americans share. Having a mortgage can be a huge | | | | discipline to invest your extra cash rather than spend |
| burden, and paying it off may be the first item on your | | | | it? If not, you might be better off making extra |
| financial to-do list. But competing with the desire to | | | | mortgage payments. |
| own your home free and clear is your need to invest | | | | Do you have an emergency account to cover |
| for retirement, your child's college education, or some | | | | unexpected expenses? It doesn't make sense to |
| other goal. Putting extra cash toward one of these | | | | make extra mortgage payments now if you'll be |
| goals may mean sacrificing another. So how do you | | | | forced to borrow money at a higher interest rate later. |
| choose? | | | | And keep in mind that if your financial circumstances |
| Evaluating the opportunity cost Deciding between | | | | change--if you lose your job or suffer a disability, for |
| prepaying your mortgage and investing your extra | | | | example--you may have more trouble borrowing |
| cash isn't easy, because each option has advantages | | | | against your home equity. |
| and disadvantages. But you can start by weighing | | | | How comfortable are you with debt? If you worry |
| what you'll gain financially by choosing one option | | | | endlessly about it, give the emotional benefits of paying |
| against what you'll give up. In economic terms, this is | | | | off your mortgage extra consideration. Are you |
| known as evaluating the opportunity cost. | | | | saddled with high balances on credit cards or personal |
| Here's an example. Let's assume that you have a | | | | loans? If so, it's often better to pay off those debts |
| $300,000 balance and 20 years remaining on your | | | | first. The interest rate on consumer debt isn't tax |
| 30-year mortgage, and you're paying 6.25% interest. If | | | | deductible, and is often far higher than either your |
| you were to put an extra $400 toward your mortgage | | | | mortgage interest rate or the rate of return you're |
| each month, you would save approximately $62,000 in | | | | likely to receive on your investments. |
| interest, and pay off your loan almost 6 years early. | | | | Are you currently paying mortgage insurance? If you |
| By making extra payments and saving all of that | | | | are, putting extra toward your mortgage until you've |
| interest, you'll clearly be gaining a lot of financial ground. | | | | gained at least 20% equity in your home may make |
| But before you opt to prepay your mortgage, you still | | | | sense. How will prepaying your mortgage affect your |
| have to consider what you might be giving up by doing | | | | overall tax situation? For example, prepaying your |
| so--the opportunity to potentially profit even more from | | | | mortgage (thus reducing your mortgage interest) could |
| investing. | | | | affect your ability to itemize deductions (this is |
| To determine if you would come out ahead if you | | | | especially true in the early years of your mortgage, |
| invested your extra cash,start by looking at the | | | | when you're likely to be paying more in interest). |
| after-tax rate of return you can expect from | | | | Have you saved enough for retirement? If you haven't, |
| prepaying your mortgage. This is generally less than | | | | consider contributing the maximum allowable each |
| the interest rate you're paying on your mortgage, once | | | | year to tax-advantaged retirement accounts before |
| you take into account any tax deduction you receive | | | | prepaying your mortgage. This is especially important if |
| for mortgage interest. Once you've calculated that | | | | you are receiving a generous employer match. For |
| figure, compare it to the after-tax return you could | | | | example, if you save 6% of your income, an employer |
| receive by investing your extra cash. | | | | match of 50% of what you contribute (i.e., 3% of your |
| For example, the after-tax cost of a 6.25% mortgage | | | | income) could potentially add thousands of extra |
| would be approximately 4.5% if you were in the 28% | | | | dollars to your retirement account each year. |
| tax bracket and were able to deduct mortgage | | | | Prepaying your mortgage may not be the savviest |
| interest on your federal income tax return (the | | | | financial move if it means forgoing that match or |
| after-tax cost might be even lower if you were also | | | | shortchanging your retirement fund. |
| able to deduct mortgage interest on your state income | | | | How much time do you have before you reach |
| tax return). Could you receive a higher after-tax rate | | | | retirement or until your children go off to college? The |
| of return if you invested your money instead of | | | | longer your timeframe, the more time you have to |
| prepaying your mortgage? | | | | potentially grow your money by investing. Alternatively, |
| Keep in mind that the rate of return you'll receive is | | | | if paying off your mortgage before reaching a financial |
| directly related to the investments you choose. | | | | goal will make you feel much more secure, factor that |
| Investments with the potential for higher returns may | | | | into your decision. |
| expose you to more risk, so take this into account | | | | The middle ground If you need to invest for an |
| when making your decision. | | | | important goal, but you also want the satisfaction of |
| Other points to consider While evaluating the | | | | paying down your mortgage, there's no reason you |
| opportunity cost is important, you'll also need to weigh | | | | can't do both. It's as simple as allocating part of your |
| many other factors. The following list of questions may | | | | available cash toward one goal, and putting the rest |
| help you decide which option is best for you. | | | | toward the other. Even small adjustments can make a |
| What's your mortgage interest rate? The lower the | | | | difference. For example, you could potentially shave |
| rate on your mortgage, the greater the potential to | | | | years off your mortgage by consistently making |
| receive a better return through investing. | | | | biweekly, instead of monthly, mortgage payments, or |
| Does your mortgage have a prepayment penalty? | | | | by putting any year-end bonuses or tax refunds |
| Most mortgages don't, but check before making extra | | | | toward your mortgage principal. And remember, no |
| payments. How long do you plan to stay in your | | | | matter what you decide now, you can always |
| home? The main benefit of prepaying your mortgage | | | | reprioritize your goals later to keep up with changes to |
| is the amount of interest you save over the long term; | | | | your circumstances, market conditions, and interest |
| if you plan to move soon, there's less value in putting | | | | rates. |