Last Updated: October 5, 2009
Much has been written of late about whether you should pay down your mortgage or not. Should you?
According to FPA member, Lora Hoff, CFP®, of IPI Wealth Management, "The decision to pay down a mortgage more quickly can be done solely on mathematical calculations. The typical question being this: Can you make more money from guaranteed investments such as CDs or government bonds than you will save by shortening the length of your mortgage?"
In general, an amortization calculator can help you calculate how much interest you will save. According to Hoff, there is a free, easy-to-use calculator that will allow you to enter all of the original loan information and then model lump-sum and ongoing extra payments to see how they affect the length of the loan and the amount of interest saved. View the mortgage calculator.
Be sure to actually run the numbers on your current carrying costs. For example, a 5 percent initial loan is an effective rate of 4.6 percent when 5 years into a 30-year amortization, after 10 years the effective rate is only 4.06 percent. "It is important to also factor in the tax savings derived from making interest payments on your primary residence," Hoff said.
On the other side of the coin, with stock and bond gains you will need to factor in the taxes that would need to be paid on any long- or short-term capital gains. It's difficult to model the cost vs. savings, but in essence you would need an investment that pays at least the same amount as the after-tax interest rate on the mortgage before the investment choice becomes a better deal.
"One other item to consider," Hoff said, "is the possibility of the economy entering a steeply inflationary period. Inflation would reduce the buying power of your dollars but also make your debt a little easier to pay off by using inflated dollars. This premise requires salaries and prices to increase with inflation while debt remains static. I think everyone who can afford to do so should have some exposure to the stock market and bonds in a diversified portfolio. It is important to determine if you will need the money in the next five to 10 years and if you can risk losing the money in the first place."
As is well known, all investments carry risk. "The more risk an investment has usually corresponds to more potential reward," she said. "Only risk what you can afford to lose. If you are losing sleep then you are taking on too much risk or you do not properly understand the vehicles in which you are investing."