Should you prepay your mortgage?
Paying off your home ahead of schedule can feel great. But don't let it interfere with the funding of your retirement accounts.
NEW YORK (MONEY) -- QUESTION: For the past year my wife and I have been putting an additional $500 per month toward the principal on our 5.25% 30-year fixed mortgage.
The psychological freedom of not having a mortgage is very appealing to us, but the argument for trying to invest the extra cash at a higher rate is compelling too. What's your take on paying off the mortgage early? - Mike, Arlington, Virginia
ANSWER: My take is that as a purely financial matter, you're probably better off investing the extra $500 a month given your low mortgage rate.
If you repay your home loan ahead of schedule, you're basically earning a 5.25% return, which represents the amount of interest you avoided paying by making the extra payments.
I think you should be able to do better than that over the long term by investing in a diversified portfolio of stocks and bonds.
But this isn't only a financial issue. As you note in your question, there is a psychological dimension to this decision. And that psychological or emotional element deserves to be taken into account as well.
The question is, how much weight does it get? If the idea of dumping that mortgage really appeals to you - if it will make you enjoy life more - then I can see devoting at least some money to prepaying your mortgage. This can especially make sense if you're timing the payoff so you enter retirement without a mortgage payment hanging over your head. For a calculator that can show you when extra payments of various amounts will make you mortgage free.
That said, however, you don't want the warm and fuzzy feeling you get from paying down the mortgage to disadvantage you in a financial sense. So before I devote any meaningful amount of my resources to early payment of a mortgage, I'd want to be sure I'm maxing out retirement plans like my 401(k) and IRAs, and that I've got a decent size nest egg going.
I'm all for going into retirement without a big monthly mortgage payment, but I also want to have a decent investment portfolio to dip into as a supplement to Social Security.
Granted, prepaying your mortgage would mean you'll have your home equity as a cushion. But while certainly accessible, home equity isn't as easily tapped as liquid investments. And besides, I wouldn't want my retirement security riding primarily on my home.
So my advice is to first make sure you're maxing out your retirement savings plans and make sure you're on track toward a comfortable retirement. Once you've got that front covered, you can start paying off that mortgage more quickly to reap those psychological benefits you find so appealing.
And one final note: If you do pay off that home loan, use the monthly cash flow that's freed up as a way to ramp up your retirement savings, not as an invitation to spend more. After all, going into retirement with a nice big six- or seven-figure investment portfolio you can draw on whenever you need it can be quite psychologically soothing too.