Ask Money

Pay off mortgage

Chris Farrell Apr 6, 2010

Question: My husband and I are interested in paying down our mortgage faster. One idea is to stop putting money into savings until the mortgage is paid off, and then increase our savings efforts with the extra monthly income. Here is the picture:

-My husband is 27 and I am 25 years old.
-We have enough liquid non-retirement savings for 1 year
-We have been fully funding my Roth IRA for 4 years, his for 3 years
-Our mortgage has 29 years left, the original amount was $172,000 at 4.5%. Our current balance is $168,500
-My husband works full time and I work part time. His job is very stable; mine is stable until the company decides they want me back full time. We have an infant daughter, plus hope to have more children in the future, so I probably will not go back full time.

Our idea was to take the money we would have applied to after-tax savings (we’ll keep our 401k contributions to meet the company match) and apply it to the principle instead. If we contribute an extra $2500/month, the mortgage will be gone in less than 5 years, and we will be debt free while our children are growing up. We were considering this option in case the market stays flat, we probably won’t lose too much on compound interest. Plus, while we have school-age children and I am no longer working, we will not have to worry about making a house payment and can use our money in other ways. Right now we cannot save for all our financial goals, but we would be able to if we did not have a mortgage payment. Is this a bad idea? Thanks, I love the show. Amanda, Tucson, AZ

Answer: First of all, you and your husband are incredible savers. Secondly, it isn’t a bad idea at all. In the heart of every homeowner burn’s an intense desire to say goodbye to the bank for the last time and to own their home free and clear. It’s a wonderful moment. Living debt free is liberating. What’s more, you have a large amount of money set aside in emergency savings and you’ll maintain your retirement savings contributions. You have a plan. Bravo.

However, I have several cautions to broach with you about this financial strategy. These are things to think about. For one thing, over the next several years you will be putting most of your financial eggs into one asset–a home. Your financial health will be more dependent than before on how that asset performs in coming years. And you’re already exposed to the local economy through your jobs. That’s why I lean toward recommending that people focus on building up a well-diversified portfolio of cash, stocks and bonds first–and not just in retirement savings accounts. Over time, a home should shrink as a percentage of your net worth. And then you pay off the mortgage.

For another, whenever you make a decision to do something–like accelerate mortgage payments–you foreclose using the money for other purposes. Economists call the value of the goods and services you sacrificed in making a choice an “opportunity cost.” It’s a measure (a very imprecise one) of what we’ve given up. It helps us better understand the return we expect from our choices. The late Robert Eisner, an economist at Northwestern University, somewhat tongue-in-cheek illustrated opportunity cost this way. The cost of buying and reading his book–The Misunderstood Economy–was not only the dollars spent on it, but also the value of the time spent reading it and the alternative use of that time. In other words, his book should only be read if you believe your return, both in enlightenment and enjoyment exceeds its opportunity cost, that is, money spent on the book and the time required to read it.

The same goes with your strategy. You could build up your savings over the next few years and that savings might allow you to take advantage of an investment opportunity if one came along or to fund a career change some time in the near future.

That said, if you’re still comfortable with the choice despite the trade-offs then I would do it.

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