6/20/2013 7:30 PM ET|
When to pay down your mortgage
It could be a smart move to get out from under your home payments, but first make sure you have your financial ducks in a row.
For years, I've been telling you that you likely have better things to do with your money than to prepay a low-rate, tax-deductible debt such as a mortgage.
Yet my husband and I plan to have our mortgage paid off by the time we retire. Am I promoting a double standard? Not really. I'm just acknowledging the math, which favors carrying a mortgage while you're working and being debt-free when you're not.
Now that mortgage rates are rising, making refinancing a less attractive option, it might be worth reconsidering how much mortgage debt you want to carry, if any. Even if you feel strongly about the importance of being debt-free, or if you're convinced you're OK carrying a mortgage into retirement, you should consider the following facts:
Retirement comes first. The longer you put off saving for retirement, the harder it is to catch up. Someone who starts at 25 should save 13% of her income to comfortably retire at age 65, according to a T. Rowe Price analysis. If she waits until age 35, she would have to save 20% of her income. By age 45, she would have to save 29%.
This just reflects the realities of compounding: The sooner you contribute into a retirement account, the longer you have to earn returns.
There are other incentives to prioritize retirement savings, including tax breaks and taking advantage of any available company match -- an instant return on your money that can be as high as 50%. So make sure you're on track for retirement before you tackle other goals.
Other debts take priority. Student loans, car loans, home equity lines of credit and other debts typically have higher rates that are often variable. That makes them a higher priority to pay off than a low, fixed-rate mortgage, especially with higher interest rates on the horizon.
You need a fat emergency fund. If you lose your job or suffer another big financial setback, a hefty savings account can help you pay the bills without going further into debt. A cash stash equal to three months' expenses is the minimum you should have before starting to pay down your mortgage. Six months or more would be better.
(Article continues below video)
You should be properly insured. Having a paid-for house won't be much comfort if you lose it in a lawsuit. Only Florida and Texas offer broad protection for homes against creditors. In other states, your home may be vulnerable. You should have liability protection at least equal to your net worth. That means maxing out the liability coverage on your homeowners and auto policies, and perhaps adding an umbrella policy that would extend those limits to $1 million or more.
The above facts apply to everyone. What could tip the scales in favor of keeping a mortgage, at least while you're working, is the relative cost of the money you're borrowing. The higher your tax bracket and the bigger your mortgage, the less of a rush you should be in to pay off the loan.
Only about half of homeowners receive any tax benefit from their mortgages. Many don't pay enough interest on their loans to itemize their deductions, either because their mortgages are relatively small or they're paying mostly principal.
If you take the standard deduction, you're not getting any tax benefit from your mortgage. Even if you itemize, the value of your mortgage deduction may be small if the amount you pay in mortgage interest and property taxes doesn't greatly exceed the standard deduction. (For 2013 the standard deduction ranges from $6,100 for single taxpayers to $12,200 for married taxpayers filing jointly.)
The homeowners who get most of the tax benefits from their mortgages are the ones like my husband and me. We have a fairly big mortgage and we're in a fairly high tax bracket. I figure the after-tax cost of our mortgage is just over 2%. Factor in inflation, and the "real" rate we're paying is around 1%. If inflation kicks up, the relative cost of the money we've borrowed could fall to zero -- or less.
The math starts to change in retirement. Most people drop into a lower tax bracket when they stop working, which reduces the value of any deductions. More importantly, the money you need to live on stops coming from a paycheck and starts coming from your savings.
Money that you pull out of savings in retirement to pay your bills is generally taxable. While the details vary by individual situations, in general it makes sense to delay or minimize withdrawals from tax-deferred accounts as long as you possibly can. Not having a mortgage is one way to do that.
Also, the higher your monthly expenses, the more savings you need to support your lifestyle. You can figure that every $1,000 in monthly mortgage payments requires $300,000 in savings, assuming you're tapping your savings at a 4% annual rate, which is generally considered a "sustainable" withdrawal rate. With no mortgage, you can comfortably retire either with less savings or with more disposable income to spend.
When you're ready to start paying down your mortgage, there are several ways to go about it:
- Pay extra every month. Just make sure the additional money is applied to your principal, not just set aside to make the next month's payment.
- Make biweekly payments. Paying half your monthly mortgage payment every two weeks essentially means making one extra mortgage payment a year. Don't pay a service to set this up; that's unnecessary. Ask if your mortgage servicer offers this option for free or at low cost.
- Refinance to a shorter loan. This locks you into a higher payment, so it may not be a good option if your income is variable or your job is threatened. If you can swing the higher payments, though, you can match the loan term to when you want to retire: a 15-year loan if you're 50 and plan to retire at 65, or a 20-year loan if you're 42 and want out by age 62.
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
More from Liz Weston:
VIDEO ON MSN MONEY
I retired 8 years ago and my house and car were paid off. Being debt free is a wonderful feeling. It gives you the options of travel and other things you could only dream of while in debt.
My advise is to get out of debt as quick as possible and do not worry about the tax advantages. Unexpected health care cost might arise. Health care and nursing homes is the monkey in the wrench of any retirement plan. .
As my 50th birthday present, my wife and I walked into BOA and paid off our mortgage in full.
It is hard to express how wonderful a feeling that was knowing that even if I lost my job that we did not have the mortgage over our heads every month.
Life is uncertain and expensive enough, so why give so much of your income away in the form of mortgage interest if you can be debt free?
Regardless of what nonsense these "experts" tell you (see who signs their checks before you listen to them) paying off debt and being debt free is the best option and will put you much farther ahead. Its a no brainer. The release of the stress and not having to worry about it anymore is more than worth the few dollars of interest you may or may not have gained by investing your money especially vs the interest you would pay by not paying down your debt.. Yes you do need to save for retirement while doing this but don't ever let someone tell you that you shouldn't pay down debt. Biggest thing is just the order as you want to hit the high interest stuff first but whatever the case, pay it all down if and when you can.
I think its time
get the longerest term mortage you can, at the lowest interest rate you can get.
make 13 payments a year, or make the usual 12 payments with an extra 1/12 each month.
have the lowest obligated payment each month in case trouble happens like an emergency.
yet paying down a little more than required each month can yield a home paid in full in 15 years on a 30 year loan.
the payback of NO MORE HOUSE PAYMENTS is invaluable!
Wow! Who woulda Thunk It ! Pay Off Your DEBTS before RETIREMENT ! Does it take a Doctorate Degree to figure That One Out ? Some amazing Wall Street AzzHole is being paid the Big Bucks to offer that information. Whiskey Tango Foxtrox Over ? SPW
How about when you don't like to pay interest or have a debt hanging over your head or when you want to use the words "my house" and not really mean "my and the bank's house" or when you have the idea that you could retire earlier without the concern for how you will be able to pay rent and instead have a very large asset that despite the recent crash, usually gains in value.
This is a no brainer. Pay off your mortgage as quickly as possible!
Whatever money savings you realize through the income tax deduction on interest associated with your mortgage is dwarfed by the amount of your income you are paying in mortgage interest to whatever bank or financial institution owns your mortgage.
It boils down to giving the bank about 10K in interest so that the IRS will give you 2K in an income tax deduction.
The math doesn't add up. Pay off the mortgage as soon as you can.
Why would anyone carry a mortgage to term? Do you know what percentage of your mortgage is actually deductably? If you don't have enough deductions to file a long form then none (0) of the interest paid is deductable. At low to mid income levels that interest paid bight give you 11 to 15 percent tax benefit. The wealthy, well who cares as they aren't us. The problem as I see it is the the other 85 to 89 percent of the amount you paid being added into the real cost basis of the home.
Form Z that tells you the total mortgage cost if paid to term even at todays low rate will about double the real cost of residence if paid to term. Lets see double the purchase price less 15 makes 185 percent of purchase price. What a deal you get to pay 185 percent of purchase price! What A Deal!!
Real solution 15 year mortgage on a bit less house and pay it off early. Like Traffic used to sing "The man in the suit has bought a new car on the profit he made off your dreams." Never pay the suits more than you have to!
The secret to retirement is having no debt, period. Living in a lower property tax state is also important. Owning your cars and home are essential. Selling your home back to the bank in your late 60's or early 70's gives you a huge influx of money when you can still enjoy spending it. The kids are on there own, they can make there own money just like we did.
Copyright © 2014 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.
MSN REAL ESTATE
Saving just a single month of expenses may take longer than you think. See how your savings rate affects how quickly you can build a solid emergency fund.
MUST-SEE ON MSN
- Video: Easy DIY smoked meats at home
A charcuterie master shares his process for cold-smoking meat at home.
- Jetpacks about to go mainstream
- Weird things covered by home insurance
- Bing: 70 percent of adults report 'digital eye strain'