Published December 01, 2010
| Get Rich Slowly
Everyone’s looking for safe investments these days. Unfortunately, there’s a price for security: low returns. A five-year certificate of deposit at a major bank like Ally pays just 2.4% APY today, and a five-year Treasury yields barely 1.5%.
But one investment offers a higher return and has the added bonus of keeping your retirement expenses low: paying down your mortgage.
What’s the “return” on that investment? At the high end, it’s the rate on your mortgage — that’s if you don’t itemize and therefore don’t deduct mortgage interest when you file your tax return. Because the majority of taxpayers don’t itemize, and with the rates on most existing mortgages landing from 4.5% to 7%, the “return” on paying off the mortgage looks pretty good.
What’s the return if you do deduct mortgage interest? Here’s the simple rule of thumb: Turn your tax bracket into a decimal and subtract it from 1, then multiply that number by your mortgage rate. That may sound complicated, but it’s not. For example, someone in the 25% tax bracket with a 6% mortgage rate would earn an after-tax return of 4.5%. Still not bad.
But there’s a bonus benefit of paying off the mortgage before kissing off the boss: You’ll have lower expenses in retirement, so you’ll need less income. The less income you need in retirement, the fewer investments you have to sell and the less money you have to withdraw from tax-deferred accounts. This will keep your tax bill lower. It also could means that less of your Social Security benefit may be subject to taxes. So you’re lowering your retirement expenses in all kinds of ways.
Weighing the Pros and Cons
So, should you send extra payments to your lender in order to pay off your mortgage earlier? First, let’s consider the benefits:
On the other hand, some conditions do warrant keeping the mortgage for as long as possible:
Who Should Prepay?
The first financial priorities for most people should be to pay off credit-card and other consumer debt, build up an emergency fund, and max out tax-advantaged retirement accounts. But once you have those taken care of, paying off the mortgage early is worth considering.
Conservative investors and those close to retirement might even consider paying off the mortgage before contributing to an IRA or 401(k), as long as they’re not passing up an employer match.
If you’re younger, the math is more in favor of keeping the mortgage, since you’ll be investing in long-term investments that have more potential to outperform the rate of your home loan. As you approach and enter retirement, your portfolio should become more conservative — which means that consistently earning 4.5% to 7.0% is not a sure thing, at least not at current interest rates.
We all want to be financially independent in retirement. Conceptually, debt is the complete opposite. It’s not impossible to owe someone money and still retire. In fact, that’s the case for most retirees. But if you’re looking for a safe way to improve your retirement prospects, especially after you’ve maxed out retirement accounts, paying off your mortgage is a solid strategy.
By Robert Brokamp,. Get Rich Slowly Contributor
Original Article: Should You Pay Off Your Mortgage Early?