11 March 2014
Pay Down Your Mortgage Faster? Six Questions to Ask First

Accelerating the payments on your home mortgage sounds like a good idea. You own more of your home faster, you pay less interest over the long term, and there’s peace of mind in owning the place you live, mortgage-free.

These are reasons some homeowners pay more each month than the minimum required by the mortgage holder, but is paying down your mortgage quickly always a good idea?

In many cases, paying off the mortgage faster doesn’t make good economic sense. In all cases, each family has to evaluate plans for the future. Before you speed up the paydown of your mortgage, think about these financial factors.

1. Are you liquid? Do you have enough cash in an emergency fund to cover household expenses in case of a financial road bump? Could you cover expenses for three months? Six months?

If you get laid off, it may take a while to find a new job, so creating a contingency fund is smart personal economics. You need liquidity – cash you can get your hands on in case of an emergency. If you pay an extra $150 on your monthly mortgage payment each month, you’re paying down your mortgage faster. However, put that $150 in an emergency account at your local bank and you’ll be covered if the car suddenly dies. Before you pay down your mortgage, build up an emergency fund for all those surprises life throws your way.

2. How’s your credit card debt? There’s expensive debt and low-cost debt. A mortgage is usually cheap money because the loan is backed by a real asset: your house. So banks can charge a lower rate on mortgage loans than, say, credit cards that are only backed by the cardholder’s promise to pay back charges to the card.  If you’re paying 17.9% on a huge credit card balance, and 4.75% on your home mortgage, pay off the expensive debt first. Instead of paying down your mortgage (cheap debt), pay down your credit card and other expensive debt first.

3. Do you max out retirement savings account contributions? Retirement savings accounts such as an individual retirement account (IRA), a simplified employee pension plan (SEP), or a 401(k) are all designed to grow tax-free until you reach retirement age.

These retirement accounts grow in value, but you don’t pay taxes on that growth until you retire. Before you pay down your mortgage, load up your retirement savings accounts to the max to increase the chances of a brighter future for yourself and your loved ones.

4. Are you keeping ahead of inflation? The longer you own your home, the greater the benefit of having a hedge against inflation. If you got your mortgage in 2002, you received the 2002 cash value of the mortgage required to buy your house. However, each year, inflation nibbles away at real cash value – sometimes by as much as 3% a year. If you have a fixed-rate mortgage, you’re actually paying less each year because you’re paying off the mortgage with today’s dollars, which are worth less than they were in 2002. 

5. Have you invested in yourself? The extra money you send to the mortgage holder each month could pay the tuition at a local school. With additional education, accreditations, and certifications, you may be able to earn more, year after year after year. Earning more equips you to build that emergency fund faster – and keep it funded when you have to tap into it. Consider investing in yourself.

6. Can you afford to lose the tax break on mortgage interest? If you’re in a high tax bracket, and you pay a lot of interest, it may not be the best move to pay down your mortgage ahead of schedule. Because mortgage interest in deductible on your tax return. Depending on how much you earn and how much interest you pay on your home, keeping your mortgage could save you thousands of dollars a year on taxes. In effect, taxing agencies give you a break on the cost of home ownership.

Further, local property taxes, energy-saving improvements, and other factors of home ownership may lower your tax liability. Talk to your accountant to make sure you get every legal deduction you can from owning a home.

Home ownership also delivers less obvious benefits. Lenders are more likely to lend to homeowners, perhaps at lower rates. Creditors are more likely to extend credit at lower rates to homeowners with a solid payment history. Enjoy the benefits of home ownership, but also enjoy the benefits of having a mortgage.

 

The information provided is presented for general informational purposes only and does not constitute tax, legal or business advice.

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