Paying Down 30-Year Mortgage vs. Refi


Dear Dr. Don, I am a 48-year-old man who plans to retire when I am 60. I will have a state pension that will pay 75% of my highest-earning year, which is approximately $45,000. I also have $40,000 in a 457 retirement fund. My current mortgage is a 5.5% fixed-rate mortgage with 27 years left to pay and a balance of $252,000.

Should I take the $400 per month I contribute to my 457 deferred compensation plan and use it to pay down my mortgage? My contributions to my 457 plan do not impact my pension benefits, as it would be a supplement to my pension. I am single and earn approximately $60,000 per year. -- David Denouement

Dear David, I think paying off the mortgage prior to retirement is a sound financial goal. So is building a retirement nest egg. In your case, I'd argue for being mortgage-free at or near retirement. Recognize your 457 plan contributions are tax-deferred, so stopping the contributions will increase your current taxable income, and you won't have the after-tax equivalent of $400 to make those additional principal payments.

While you're looking at making additional principal payments, you might as well consider refinancing the house. If you went from your 30-year fixed-rate mortgage at 5.5 percent to a 15-year mortgage at Bankrate's national average of 3.48%, you'd increase your monthly payment by about $310 but have the loan almost paid off by your planned retirement date. As the table below shows, you'd also have saved on a pretax basis almost $67,000 in interest expense versus just making additional principal payments on your current loan.

What's the downside of refinancing to a 15-year loan versus making the additional principal payments on your existing mortgage? When you're refinancing into the shorter loan, you're making the higher monthly mortgage payment contractual. You could always skip making an additional principal payment. You can't skip making a mortgage payment, at least not without financial consequences.

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