VOL. 127 | NO. 204 | Thursday, October 18, 2012
Rays of Wisdom
Dana and Ray Brandon
Think Twice Before Pre-Paying A Mortgage
By Ray and Dana Brandon
Ray’s Take With savings interest about nil and the stock market still volatile, a lot of people are wondering about paying off their mortgage early. For some, this may be a good idea, as we have all discovered a healthy respect for debt, but for other homeowners, there may be better options for extra cash.
For example, it’s far wiser to pay off any other debts first – particularly credit card debt. After all, credit card interest is typically at least 10 percentage points higher than mortgage debt. That’s a huge difference!
You would probably be much better off investing in a retirement account as well. At the very least, you should be trying to max out contributions to your 401(k). Not only do investments in IRAs and 401(k)s have tax advantages, they have historically delivered returns higher than any savings you may gain from paying off your mortgage early.
Finally, it’s important to have money set aside for possible emergencies, such as losing your job or unexpected health issues. You should have at least six months of monthly expenses where you can easily access the funds, like a money market account. Twelve months would be even better.
If you are debt free, saving for retirement, and have your emergency fund well supplied, you might consider pre-paying on your mortgage. However, since mortgage interest rates are currently so low and you can usually deduct mortgage interest, paying off a mortgage early simply doesn’t save you much money – possibly as little as three percent. Another way to look at it is that you are increasing your real estate asset allocation. Maybe a good move – maybe not.
One exception could be for those nearing or in retirement who still have a mortgage. If you’re in the final years of a 30-year mortgage, the tax advantages of interest deduction have diminished significantly. By removing one significant monthly payment, more money could go toward basic needs.
It’s a lot to consider. So, before you decide to make those extra, early mortgage payments, think twice. That might not be your best option investment-wise.
Dana’s Take Paying off a mortgage is a dream come true. The best way to accomplish that goal is to start small on that first home purchase.
Once upon a time, a “starter home” was big enough for a couple and later, a few kids. Sometimes people kept that home for a lifetime. My mother-in-law grew up with two brothers in a house with one bathroom. All three kids finished college with no student loans. Get the picture?
Today, I see McMansions with a Little Tikes play set in the yard. When a couple is just starting out, I’m not sure that being tied to a monster mortgage is the best use of resources. That kind of debt requires non-stop employment and guarantees nonstop stress.
If the goal of buying a home is “happily ever after,” keep that first cottage simple and realize your dreams.
Ray Brandon is a certified financial planner and CEO of Brandon Financial Planning (www.brandonplanning.com). His wife, Dana, has a bachelor’s degree in finance and is a licensed clinical social worker. Contact Ray Brandon at email@example.com.