Should You Pay Down Your Mortgage?

Are you wondering whether or not you should make extra mortgage payments? A person at CNN Money asked just that:

My wife and I are both 28 and contribute enough to our 401(k)s to get the full company match. We are putting most of our extra money towards paying down our mortgage. Is that a good use of our money or should we be investing more for retirement?

Money's answer:

There's no official correct answer, but I think you would be better off focusing more on retirement than on paying off your mortgage ahead of time.

Their bottom line reasoning for recommending this method:

The question really is, can you earn more than 6 percent [the cost of a mortgage] on your money by investing it somewhere other than your mortgage?

That depends on how you invest the money. Given a mix of, say, 80 percent stocks and 20 percent bonds -- hardly too racy for someone not even 30 yet -- I think you should have a very good shot at earning 6 percent or better over the long term.

Of course, the investing return isn't guaranteed. If you're prepaying a fixed-rate mortgage, on the other hand, you are locking in a return. But if you're investing this money for a very long period of time, I think it's a good bet that the returns to a mostly stock portfolio will beat the returns of a debt instrument such as a mortgage.

So at this point in your life, I think it makes more sense for you to get a good head start on building your retirement nest egg, and the best way to do that is for both of you to max out on your 401(k)s, and then funnel any extra cash into other tax-advantaged accounts such as a deductible or Roth IRA or even into mutual funds or other investments in taxable accounts.

Besides, if you haven't paid off your mortgage by the time you're ready to call it a career, you can always consider paying it off at retirement by tapping into that nice big nest egg you've built.

Personally, I'm a big believer in no debt (for a number of reasons) and might advise otherwise, depending on a person's specific situation. Besides, it seems like every person I've known who says "I won't pay down my mortgage but instead invest it and will earn more" never quite gets around to investing it -- they spend it instead. Then they are no better off -- their mortgage is not paid down and their investments are not any larger.

Comments

[Terri W.]

For my husband and I, we also see it as an issue of cash flow -- it's our goal to have our mortgage paid off before our first college tuition payment, likely about 16 years in our future. [We're two years into our 30 year mortgage, but have already paid the principal down about 20% - we had reasons for not getting a 15yr.] We're being pretty agressive, but not at the expense of retirement or emergency savings. If anything, it's just pushing our next car out a few more years, and that's a good thing in and of itself.

[mbhunter]

Thank you FMF. I don't hear this nearly enough. It's a good idea to pay down one's mortgage.

It doesn't surprise me in the least that CNN Money recommends maxing out investment vehicles instead of paying down the mortgage. Look who advertises in that magazine -- mutual fund companies and brokerage houses, mainly!

It's also worth noting that the interest savings gained by accelerated mortgage payments is "tax free" as an "investment," since the government -- fortunately! -- doesn't categorize "money that we don't spend on interest" as income. You get a slightly lower "return" than your mortgage rate (in the form of mortgage interest not paid and the corresponding increase in equity) for each additional dollar you pay toward principal. You might lose a little of that mortgage interest federal tax deduction, but hey, that's all right with me!

[Jason]

I am curious to know what you and your readers might think of a variation of this dilemma. I am trying to decide if it is better to have an emergency fund of six months of expenses or to use those funds to pay down our HELOC.

Thanks and I enjoy everything that Free Money Finance has to offer.

[mbhunter]

Jason, those are both good things to do. I'd try to knock down the HELOC but that's only my personal opinion, and you should run the numbers yourself or consult a qualified financial planner since I can't address your personal concerns in a blog comment ;)

A lot depends on the balance of your HELOC, how much you're paying a month, how much you have socked away in an emergency fund already, and how much you can afford to contribute to these ends. Also, you might see if your HELOC has an adjustable rate, and gauge where interest rates are heading to see what kind of risk is there. Do you have purchases coming up? Other expenses? A financial planner can help you sort out all of these details if all of the what-ifs stymie you.

[thc]

Mortgage money is cheap, cheap, cheap and the interest is tax deductible. Do not pay it down earlier than necessary--invest excess cash. If you don't have the dicipline, find someone to help you.

[Jose]

To avoid the "don't get around investing it" issue... Make investing automatic: Most brokerage houses can extract money from a bank account and deposit it into a mutual fund account. You can also increase 401k.

However, once you MAXIMIZE your 401k, AND maximize your IRA, AND have a rainy day fund, AND pay credit card... paying down the mortgage is not terrible.

I would automatically invest the extra income into the Vanguard 500 fund, however.

[FMF]

Jason --

Here's what I would do -- keep 3 months as an emergency fund and use the rest to pay down the loan. That may or may not be right for you, so consider the comment worth what you paid for it. ;-)

FMF

[Andy]

My co-workers call me a scrooge because I never carry cash but instead, use a credit card for nearly all purchases I make. I use the points I earn to fly to my sister's in Arizona. While I don't carry cash, I leave generous lunch tips and never dicker about how a bill should be split up. Does this all seem "cheapskate" to you?

[FMF]

Andy -- Did you mean to comment to this post? It seems a bit out of place. Or am I missing something?

[Mike]

For us, it's about paying off our loan so we have security in case we lose our jobs. We're in the high-tech industry, and lay-offs are all too common. I already have 6 months expenses in a savings accoutn and having our mortgage paid off in 5 years (which is our current plan) will give us less to worry about if we get laid off. Anyway I'd take 5 3/8 % guaranteed over any amount I might make in some fund, anyday. Hey, if the mortgage company thinks it's a good investment, why shouldn't I?

[Randy]

I am seven years from retirement. My mortgage balance is only $23000. Since I can no longer deduct the interest on my taxes, I will pay it off.

[Pat Genn]

I am 68 yrs. old & single. I still work parttime because I have a $500.00 monthly mortgage. I owe $60,000 on my house and I have $20,000 in an IRA. Question should I take the mioney from the IRA and pay on the mortgage??? I have no other savings except the IRA>

[Rich]

I am a single professional with one income. My observation is that pre-payment of mortgages is useful. When the economy goes bad, investments go bad, and employment can go bad. Pre-paying especially if it can linked with occasional re-financing the lower principal loan has a definite effect on cash-flow and peace of mind. I had paid off a small condo and had monthly expenses of less than $600 per month. It enabled me to have far more disposable income for other investment opportunities and more importantly offered me the freedom to take advantage of those opportunities since if all went wrong, all I had to do was pay for food and minimal taxes. That was freedom. I rolled that equity into an investment property with a significant mortgage. Even with ample cash reserves it is stressful knowing that I have to meet my monthly debt. You can get cash-flow positive two ways; increase income or reduce debt. Pre-paying a mortage in some proportion to other investments is a tool to work both sides of that equasion simply while being able to sleep at night. Of course it helps to live as simply and cheaply as possible. My goal is always to live off one paycheck per month.

[Rich]

I am a single professional with one income. My observation is that pre-payment of mortgages is useful. When the economy goes bad, investments go bad, and employment can go bad. Pre-paying especially if it can linked with occasional re-financing the lower principal loan has a definite effect on cash-flow and peace of mind. I had paid off a small condo and had monthly expenses of less than $600 per month. It enabled me to have far more disposable income for other investment opportunities and more importantly offered me the freedom to take advantage of those opportunities since if all went wrong, all I had to do was pay for food and minimal taxes. That was freedom. I rolled that equity into an investment property with a significant mortgage. Even with ample cash reserves it is stressful knowing that I have to meet my monthly debt. You can get cash-flow positive two ways; increase income or reduce debt. Pre-paying a mortage in some proportion to other investments is a tool to work both sides of that equasion simply while being able to sleep at night. Of course it helps to live as simply and cheaply as possible. My goal is always to live off one paycheck per month.

[Jeremy B]

This is a fantastic system for paying down debt very quickly. People fear the unknown, and I think this is why most haven’t caught on to this yet. It is called a money merge account. It helps people pay down their mortgage debt very quickly without changing their normal budget. The only qualifications are simple. They need to have at least a little money let over each month after all expenses, they need to have about a 600 score or better credit, and they need to stick to their budget. If they follow the web based software that guides them the whole way through they will payoff a 30yr loan in about 15 or less years, following the same budget they currently are on. This video link will explain in great detail how the system works. I am not saying it is for absolutely everyone, but if you qualify with the above, you should watch the video, and call me with any questions.

[Joe]

In many scenarios, paying down your mortgage is the wrong financial move. After a company matched 401(k), get a Roth IRA if you qualify. Have a look at this link for a detailed analysis I did in a real world young homeowner scenario. The difference after 30 years is over $200,000 advantage to smart investing versus paying down the mortgage.

[Lynne]

Pay down the mortgage and become absolutely debt free. You can live in the house, but you can't live in your worthless stock investments those stock brokers want to sell you. The mortgage interest was paid at the start of the loan so by the time you finish the mortgage, not much is left to deduct for taxes anyway..So forget those consultants who want you hard earned money so they can pay down their mortgage and pay your self.