Ask Money

Diversify or accelerate mortgage payments?

Chris Farrell Aug 17, 2011

Question: I’m 54 years old and have 25 years left on my mortgage. If I re-fi at a lower rate and drop to 15 years, my payment is the same. I also pay about $250/mo extra to principle. Would I be better off to stop paying to principle and invest that $3000/year for retirement, in addition to my current 14% contribution? John, North Las Vegas, NV

Answer: We’re getting more and more questions about the wisdom of accelerating mortgage payments. My basic guidelines for thinking through the questions haven’t changed, but the particular advice depends on circumstances.

There are many reasons for owning your home outright. Goodbye to debt and the banker. You can earn a higher rate of return on your money paying down the mortgage than you can make putting the money into savings. Homeowners should enter their retirement years without debt. No mortgage adds to your financial stability and cash flow, allowing you to work less if you want or do take a job that pays less but with greater emotional rewards.

So, why not stretch to pay down the mortgage fast? The concerns all revolve around risk. You’re sinking money into a single asset that is located where you also make a living. That’s a lot of financial exposure to one area. The big advantage of putting the money into savings and investments is that you’re building up a well-diversified portfolio locally, regionally, nationally and internationally.

As I wrote in this recent post, it also matters how secure you are in your job and that you won’t change your mind about living in the home.

Cash is king in the turbulent economy we live in. I don’t see that changing anytime soon. Cash is not only an emergency fund against an expected or unexpected setback, but it’s also an “opportunity fund” that lets you take advantage of intriguing investments that come your way.

In most cases I lean toward diversification, building up savings and investments outside the home first. I would then shift to paying it quickly once the home has shrunk in importance to your overall financial situation.

There is one other twist to the tale: There is no prepayment penalty with most mortgages. You can always build up your savings and, several years from now decide the best use of the money is to get rid of it.

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