Paying Off Your Mortgage
There are advantages and disadvantages to paying off your mortgage. On the positive side, any extra money sent with your mortgage payment is applied to the outstanding principal, which can significantly reduce your total interest cost. This reduces your interest expense deduction on your tax return, but you are paying most of the cost anyway. For instance, if you’re in the 24% tax bracket, you save 24 cents in taxes for every dollar of interest, but you’re still paying the remaining 76 cents.
When paying down principal, you are effectively earning a pretax return equal to your mortgage interest rate, which is a guaranteed return with no risk. Most mortgages allow you to add as much to the payment as you like, whenever you like, making it an easy way to use excess funds. However, check with your specific lender to determine if prepayment penalties apply.
On the other hand, instead of prepaying your mortgage, you might want to put additional funds toward investments with the potential to earn higher returns. Also, once you make the additional mortgage payments, the only way to access that money is to sell your home or take out a home-equity loan, usually at a higher rate.
Consider the following factors before prepaying your mortgage:
Are all components of your financial plan in place? Before prepaying your mortgage, make provisions for things like disability insurance, life insurance, and an emergency fund.
Is all your consumer debt paid off? Consumer debt typically carries higher interest rates than your mortgage rate, and interest payments are not typically tax deductible, unless it’s a home-equity loan. Thus, you should probably pay off your consumer debt in full before making additional payments on your mortgage.
Are you maximizing contributions to qualified retirement plans? Make sure you are contributing the maximum to your 401(k) plan, especially if your employer matches funds, or are fully funding other qualified plans and individual retirement accounts. Have you investigated investment alternatives? Look into other investments whose potential returns may exceed the return from prepaying your mortgage. However, make sure you actually make those investments. You don’t want to just spend any money that could have gone toward your mortgage. Are you nearing retirement? The idea of entering retirement with no debts may make prepaying your mortgage a more attractive alternative. Or you may like the certainty of positive returns that comes from prepaying your mortgage. If you decide to prepay your mortgage, consider these strategies:
Switch from a 30-year to a 15-year mortgage. By paying the mortgage off 15 years sooner, you save a significant amount of interest. Pay half your mortgage payment every two weeks. Over the course of a year, that equals 26 payments or 13 monthly installments. Check with your lender to make sure this option is offered. Add additional amounts to your monthly mortgage payment. This option is the most flexible since you decide on a monthly basis how much to add to your payment.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.