Should You Prepay Your Mortgage? |
Your home mortgage payment is probably the biggest bill you pay every month. Everyone dreams about someday paying off the mortgage on their home. If you prepay your mortgage by making extra payments toward the principal, you can shorten the time it will take to pay off your mortgage. Paying off your mortgage early sounds great, but there are a number of things you should be doing before you consider prepaying your mortgage:
Payoff all your credit cards, car loans and other consumer debts. You should payoff any other short-term debts or any debts with
Payoff all your credit cards, car loans and other consumer debts. You should payoff any other short-term debts or any debts with
higher interest rates before you start to make extra principal payments on your home mortgage.
Set aside 3-6 months living expenses in an emergency fund. An emergency fund is used as a safety net if you are laid off from work or to fund unexpected expenses such as major car repairs or repairing a leaky roof.
Make the maximum pre-tax contribution to your 401k. The ability to make pre-tax contributions to your 401k and have your investment returns compound tax-deferred for decades is a huge benefit. Don’t squander the opportunity to save tax-deferred and at the same time reduce the tax benefits of your home mortgage.
Make the maximum contribution to your Roth IRA. While Roth IRA contributions do not reduce your taxable income, they do allow your investment returns to compound tax-free.
Set aside money for future major purchases. Once you have paid down your home mortgage, getting the money back out for major purchases such as home improvements or a new car can be inconvenient and expensive. Before you start prepaying your mortgage, make sure you set aside the cash to pay for the major expenses you anticipate in the future.
Save for your retirement. Paying off your mortgage is not a substitute for saving for your retirement, but eliminating your home mortgage payment before you retire can be part of your overall retirement plan.
Save for your children’s education. Coverdell Education Savings Accounts and state 529 plans are tax advantaged ways to set aside money for your children’s education.
Pay off any second mortgage, home equity loan or home equity line of credit. A second mortgage or home equity loan are generally fixed at a higher interest rate than your first mortgage. A home equity line of credit may have a lower adjustable interest rate, but the interest rate and your payment can adjust up or down based on interest rate market conditions. In either case, these types of loans should be completely paid off before you start to prepay your first mortgage.
Another disadvantage to prepaying your mortgage is you can lose all the equity you have built up if you lose the house in a foreclosure or an uninsured calamity.
Set aside 3-6 months living expenses in an emergency fund. An emergency fund is used as a safety net if you are laid off from work or to fund unexpected expenses such as major car repairs or repairing a leaky roof.
Make the maximum pre-tax contribution to your 401k. The ability to make pre-tax contributions to your 401k and have your investment returns compound tax-deferred for decades is a huge benefit. Don’t squander the opportunity to save tax-deferred and at the same time reduce the tax benefits of your home mortgage.
Make the maximum contribution to your Roth IRA. While Roth IRA contributions do not reduce your taxable income, they do allow your investment returns to compound tax-free.
Set aside money for future major purchases. Once you have paid down your home mortgage, getting the money back out for major purchases such as home improvements or a new car can be inconvenient and expensive. Before you start prepaying your mortgage, make sure you set aside the cash to pay for the major expenses you anticipate in the future.
Save for your retirement. Paying off your mortgage is not a substitute for saving for your retirement, but eliminating your home mortgage payment before you retire can be part of your overall retirement plan.
Save for your children’s education. Coverdell Education Savings Accounts and state 529 plans are tax advantaged ways to set aside money for your children’s education.
Pay off any second mortgage, home equity loan or home equity line of credit. A second mortgage or home equity loan are generally fixed at a higher interest rate than your first mortgage. A home equity line of credit may have a lower adjustable interest rate, but the interest rate and your payment can adjust up or down based on interest rate market conditions. In either case, these types of loans should be completely paid off before you start to prepay your first mortgage.
The Advantages Of Prepaying Your Mortgage
Assuming you don’t end up losing your home in some calamity, the money you use to prepay your mortgage will often have a higher rate of return than other taxable savings options. Paying off your mortgage can also give you peace of mind, because you no longer have a large mortgage payment (and debt) hanging over you. Once you have paid off your mortgage, the money that you would ordinarily use to pay your home mortgage is available for saving or investing.The Disadvantages Of Prepaying Your Mortgage
The main disadvantage of prepaying your mortgage is that accessing the equity you have built up in your home could be difficult or expensive. If you lose your job or experience a personal financial downturn, you could find it difficult to refinance your home or get a home equity loan. Accessing the equity in your home could also be very expensive if you are forced to refinance or take a second mortgage on your home at a time when interest rates are substantially higher than your current mortgage interest rate. Even if you can refinance your home at a good interest rate, you should also consider the fees involved in the transaction.Another disadvantage to prepaying your mortgage is you can lose all the equity you have built up if you lose the house in a foreclosure or an uninsured calamity.
Should You Prepay Your Mortgage?
On a list of financial priorities, paying off your mortgage should probably rank pretty low. After addressing more pressing financial matters, starting on a program to pay off your mortgage by the time you retire can make good financial sense.
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