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When to get aggressive with the mortgage paydown

Chris Farrell Dec 15, 2011

Question: I hear on a lot of shows the question of whether to put extra cash towards your mortgage or invest it for retirement. Just last week someone asked this on Marketplace Money. Of course there are questions about whether you will stay in your house, how much you already have in retirement… but it often comes down to simply saying that it makes no difference. 

Say you have a 4.75% mortgage and you pay $1000 extra on it and you have 20 years left. When you calculate what you will save in payments, isn’t this the same amount you could earn putting your money in a 20 year CD at 4.75%? 

My question is, if your mortgage rate is higher than what you could expect from investing, wouldn’t it make more sense to pay on the mortgage? This is almost the same as the concept of paying off the credit card with the highest rate first. What are your thoughts on this?  John, Rapid City, SD 

Answer: You’re absolutely right about the rate of return equivalence between investing in a CD at 4.75 percent and paying off a mortgage with an interest rate of 4.75 percent. You’re definitely getting a higher rate of return on accelerating payments on a 4.75 percent mortgage  compared to earning, say, 0.1 percent to 1 percent on a savings account. 

However, rate of return is only one part of the calculation. I think there’s a lot more to consider. What you decide makes a big difference to your household finances.   

First, let’s look at the good reasons for paying off a mortgage on an accelerated schedule. You get to say goodbye to the debt and the banker for the last time. Whew!

Living in a home without a mortgage is a strong financial safety net if you lose your job or suffer some other kind of setback. Many people feel free to pursue work they love even if it doesn’t pay well if they own their home. And as you pointed out you can earn a higher rate of return these days by targeting the mortgage rather than siphoning money into a savings account.  You save thousands and thousands of dollars in interest. Homeowners should enter their retirement years without debt. What’s not to like?

Well, I’m wary of the practice since there are risks as well as benefits to accelerating mortgage payments. To be clear, I’m assuming we’re weighing the trade-offs of an aggressive paydown strategy vs. an aggressive savings strategy. There is nothing wrong and everything right about making 13 mortgage payments a year or adopting a bi-weekly mortgage payment discipline. Both techniques are sound moves that save on interest payments.

No, the questions I’m raising involve homeowners contemplating a much faster repayment schedule.

For one thing, I’m wary because you’re putting more of your hard-earned savings into a single asset located where you also make a living. It’s a lot of financial exposure to one asset and one area.

A big advantage of investing extra money into savings is that you’re building a well-diversified portfolio exposed to the national and global markets. The financially tumultuous experience of the past several years reinforces the old adage: Don’t put all your savings eggs in one asset.   

I think there are a number of other questions to think through before putting extra money into the mortgage every month. For instance, how secure is your job and career where you live? If you did get a pink slip would you stay in your community or leave town to get a job? We’ve dealt with so many unemployed people in recent years that found work in another town but couldn’t sell their home. Are you in the home and neighborhood you want to stay in? In other words, are you in it for the long haul? How flush are your emergency savings/opportunity fund and your retirement savings accounts? 

In these difficult times I lean toward emphasizing saving and investing outside the home.  The cash portion of a healthy savings account isn’t only an emergency fund. It’s also an “opportunity fund” that lets you take advantage of intriguing developments that come your way. It critical to fund a healthy retirement portfolio.  

Not everyone agrees with me on this, but I would wait until the home has shrunk in importance to your overall financial situation before speeding up mortgage payments.

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