Owning a home outright is a dream that many Americans share. At the same time having a mortgage can be a huge burden, and paying it off may be the first item on your financial to-do list. Deciding between prepaying your mortgage and investing your extra cash isn’t easy, because each option has advantages and disadvantages.
The following list of questions may help you decide which option is best for you.
What’s your mortgage interest rate? The lower the rate on your mortgage, the greater the potential to receive a better return through investing.
Does your mortgage have a prepayment penalty? Most mortgages don’t, but check before making extra payments.
How long do you plan to stay in your home? The main benefit of prepaying your mortgage is the amount of interest you save over the long term; if you plan to move soon, there’s less value in putting more money toward your mortgage.
Will you have the discipline to invest your extra cash rather than spend it? If not, you might be better off making extra mortgage payments.
Do you have an emergency account to cover unexpected expenses? It doesn’t make sense to make extra mortgage payments now if you’ll be forced to borrow money at a higher interest rate later. And keep in mind that if your financial circumstances change–if you lose your job or suffer a disability, for example–you may have more trouble borrowing against your home equity.
How comfortable are you with debt? If you worry endlessly about it, give the emotional benefits of paying off your mortgage extra consideration.
Are you saddled with high balances on credit cards or personal loans? If so, it’s often better to pay off those debts first. The interest rate on consumer debt isn’t tax deductible, and is often far higher than either your mortgage interest rate or the rate of return you’re likely to receive
on your investments.
Are you currently paying mortgage insurance? If you are, putting extra toward your mortgage until you’ve gained at least 20% equity in your home may make sense.
How will prepaying your mortgage affect your overall tax situation? For example, prepaying your mortgage (thus reducing your mortgage interest) could affect your ability to itemize deductions (this is especially true in the early years of your mortgage, when you’re likely to be paying more in interest).
Have you saved enough for retirement? If you haven’t, consider contributing the maximum allowable each year to tax-advantaged retirement accounts before prepaying your mortgage. This is especially important if you are receiving a generous employer match. For example, if you save 6% of your income, an employer match of 50% of what you contribute (i.e., 3% of your income) could potentially add thousands of extra dollars to your retirement account each year. Prepaying your mortgage may not be the savviest financial move if it means forgoing that match or shortchanging your retirement fund.
How much time do you have before you reach retirement or until your children go off to college? The longer your timeframe, the more time you have to potentially grow your money by investing. Alternatively, if paying off your mortgage before reaching a financial goal will make you feel much more secure, factor that into your decision.
And remember, no matter what you decide now, you can always reprioritize your goals later to keep up with changes to your circumstances, market conditions, and interest rates.
The following information is reprinted with permission from Forefield, Inc. Copyright 2006-2010.