November 12th, 2010 8:47 AM by Lehel S.
AYING off a mortgage or even paying down the balance early might seem enticing to most borrowers. There’s the big savings in interest payments and the freed-up cash flow that can result, not to mention the emotional benefit of wiping out what for most people is the largest financial burden of a lifetime.
With interest rates as low as they are these days it may be easier to make those additional payments. But deciding whether to do so requires a careful balancing of math and psychology, financial advisers say.
Even an extra $25 a month toward the mortgage means having less money for emergencies that might crop up. It also translates into less money to plow into otherinvestments, as well as a lower mortgage-interest tax break, since you’re paying less interest as you pay down the principal (or none at all, if you’ve paid it off).
The most important factor, according to Bill Losey, a certified financial planner and the owner of Bill Losey Retirement Solutions in Wilton, N.Y., is that if you can make more money over the long haul in other investments like stocks than you can by paying off your mortgage early, it’s probably not worth it.
“People look at things in black and white,” Ms. Losey said, “and I see a lot of people who say they want to be debt-free. So they plow money into their house, but don’t save as much. But I hate to see all your assets wrapped up in the equity of your house.”
If you have, say, a 30-year fixed-rate mortgage for $400,000, taken out this month at 4.25 percent, then paying $200 a month on top of your monthly payment of just under $1,968 (for interest and principal) would save you $58,496 in interest and shave five full years off your loan. (There are several Web-based early-payoff calculators; one is atBankrate.)
Appealing? Yes. But is it worth it?
Because of the mortgage-interest deduction, that $58,496 is really costing you $42,117, assuming you’re in a 28 percent federal income tax bracket. So that 4.25 percent rate is really better seen as 3.06 percent.
Can you earn at least that much by putting that extra $200 into stocks? It all depends, of course, on timing. From 1990 through 2009, for example, the Standard & Poor’s 500-stock index had an annualized return of 8.23 percent. But from 2000 through 2009 the return was a negative 0.99 percent, though the market has improved this year.
“Right now, if you can earn better than 4.4 percent after taxes,” Mr. Losey said, “you’re probably better off investing the money than using it to prepay your mortgage.”
Of course, you can often cut your interest payments by refinancing into a shorter-term mortgage, rather than paying down your loan early, but you will very likely incur thousands of dollars in refinancing costs. Borrowers considering a mortgage payoff must check whether their loan carries prepayment penalties that could cost thousands of dollars; many subprime loans do.
Making extra mortgage payments is ill advised if you have large credit-card balances, which typically carry a higher interest rate. It’s better to pay off the higher-interest debt first.
And if there’s a chance you might lose your job or lose some of your income, pouring extra cash into a mortgage payment may also be a bad idea.
Biweekly programs let you get in an extra mortgage payment every year, reducing principal and interest sooner. But the consultants who set them up typically charge annual fees in the hundreds of dollars, as well as small transaction fees for each payment, which could cancel out any financial benefits.
If you do have a cash crunch once your mortgage is paid off, you’ll have equity to tap, but in the form of home-equity loan or a Heloc (home equity line of credit), which carries an adjustable interest rate, thus exposing you to higher payments on that loan if the market shifts.