Here's a piece from Money Central that talks about how people are making wrong decisions by paying off their mortgages early. That's the attention-grabbing headline anyway. The real story is that many people are paying off their mortgages before making other, more lucrative, financial moves. Here are the details:
You normally don't think of people who prepay their mortgages as being wasteful or careless. But a recent study suggests these households blow more than $1.5 billion a year, or $400 per household, by accelerating their mortgage payments instead of contributing more to their retirement accounts.
The research found that at least 38% of those who were making extra payments on their mortgage were "making the wrong choice." Instead, these households would get back 11 to 17 cents more on the dollar by putting the money into a workplace retirement plan like a 401(k).
I'm a big fan of paying off your mortgage early -- it's the last step in my formula for buying a house -- so I had to comment on this piece.
I would certainly agree that there are other financial moves to make before paying off a mortgage. But that doesn't mean paying off a mortgage is wrong, it simply means that it's a bit lower on the list than other options.
So what other options would be above paying off your mortgage? Here's my list:
1. Contributing to your 401k to get the full employer match. It's a no-brainer to put in money when an employer is matching it dollar-for-dollar or 50 cents on the dollar. It's hard to beat a 50% to 100% return on your money.
2. Pay off your credit cards. This is likely the highest interest debt you have, so get rid of it first.
3. Pay off any other debt that has a higher interest rate than your mortgage. For instance, your car loan, the doctor's bill, etc.
4. At this point, I'd recommend paying off your mortgage. Many others would say that as long as you think you can earn more on your money investing, growing a side business, etc., then you should do those things before paying off your mortgage. I disagree -- for various reasons I've discussed before -- but here it becomes more of a personal preference. For me, I wanted to be debt free and thus paid off my house. I now have plenty to invest and no debt whatsoever. If nothing else, that feeling of financial freedom is priceless.
I would insert:
3.5 Establish emergency savings
Posted by: Duane Gran | February 02, 2007 at 11:03 AM
And I would insert:
3.7 Fully fund your Roth IRA
Posted by: EMF | February 02, 2007 at 01:13 PM
3.6
-Contribute to your 401k to get the full pre-tax deduction allowed. Even without an employer match, the tax benefits are large enough to place this above paying off the mortgage.
-Contribute the maximum to an IRA (deductible, Roth or non-deductible, in that order, as permissible according your situation). The amount is not that large, and the long-term tax advantages are significant.
Posted by: Nigel | February 02, 2007 at 01:28 PM
In re to Nigel:
I would not put 401k contributions beyond the employer match in front of a Roth IRA. The more tax _deferred_ savings you have, the more likely you will be pushed into higher tax brackets in retirement along with pushing more and more Social Security benefits into being taxed. Even if you believe SS will go away, being in a position of having tax diversification may have its benefits. Also, I think that tax rates will generally go up in the future -- today's 15% bracket may turn into 20%.
And as to whether additional 401k contributions are more beneficial than pre-paying the mortgage, I'd have to analyze that given years-to-retirement and whether I'd still be paying a mortgage in retirement, along with rates of return, etc.
Posted by: EMF | February 02, 2007 at 02:01 PM
I would recommend paying it off at retirement. Paying interest you can't deduct because your income is too low doesn't make sense and paying it off can lower your income and expenses, lowering your tax burden without lowering your standard of living.
Posted by: Lord | February 02, 2007 at 02:18 PM
Good thoughts! Thanks for making this better Duane, Nigel and EMF!
Posted by: FMF | February 05, 2007 at 08:31 AM
One of the things that happens when you pay off a debt is that your monthly expenses go down. That has two immediate effects. The money you have available for other things increases. You can invest it or spend it. The second is that the time that your emergency savings will last becomes proportionately longer.
Posted by: Anonymous | February 05, 2007 at 05:07 PM
Except with retirement accounts you can never go back and catch up.
Posted by: LivingAlmostLarge | March 14, 2007 at 09:08 PM
my husband passed away dec 2007 i've just gotten 500k from life insurance the insurance agent wants to invest all of it and give me an allowance a month. I'm 40 two children who have their own 85k each when they hit maturity. I owe 230k on my house I have a job and ss for the kids untill they are 18 ( 9 & 11 now) I want to pay off my mortgage invest 150k for retirement and have the balance for emergency also smaller investments. I feel like he's pushing me he also wants control of the childrens UTMA accounts once I have guardianship. What sounds right. I'm picking up the check today. HELP
Posted by: barbara | May 16, 2008 at 10:56 AM
Barbara --
I posted your question. Click this link for reader responses/suggestions:
http://www.freemoneyfinance.com/2008/05/help-a-reader-5.html
Posted by: FMF | May 16, 2008 at 11:38 AM
Invest = BAD right now in my opinion.
Posted by: K.Post | October 07, 2008 at 02:10 AM
The most overlooked point most people don't consider is the front end loading of a mortgage or any long term loan. It is not the interest rate that is the key but the term of the loan. The longer the term the higher the front end loading. I agree that you should take the match on any retirement plan first. Figure the interest paid divided by the principle paid and you find you are paying a high rate of %.What is overlooked here is the savings a person has by paying off the principal of the mortgage to save 2 to 1 on the interest. That goes to the home owners balance sheet not the banks.
Posted by: Claude McKinney | March 25, 2009 at 07:42 PM