Paying off a mortgage early can be good financial strategy 10/19/2008 1:34 AM By GREG ROBERTS Columnist
Question: My parents left me a little over $50,000 when they passed away. I am debating whether I should pay off my remaining mortgage balance of $45,000, which has a 7 percent fixed rate, or invest the $50,000 in the stock market to supplement my retirement income. I am 54. My current monthly mortgage payment is $900. What do you think?
Greg's answer: You should consider yourself fortunate that you are in this situation and not facing a foreclosure. Normally, I would recommend that you consider refinancing, but not in this environment.
Regarding this question, the first issue is: does your mortgage have a prepayment penalty? If it does not, then paying off your mortgage early will provide you a return equal to the mortgage interest rate, in this case 7 percent. That return must be compared to the rate that you would receive from alternative investments, but your rate of return will fluctuate over the next 11 years, based on how well your stock market investments would perform. A 7 percent return is certainly not bad, and by paying off your mortgage early, you can still invest in the market. One thing is certain - you should make every attempt to pay off your mortgage by the time you retire.
Based solely on the information that you have given me, I would pay off the mortgage early, and then meet with my financial adviser and select a good mutual fund that offered different types of investment accounts (growth, money market, income, etc.) Your financial adviser can help you select an allocation strategy for your investment dollars that will be in sync with your risk profile. I would then invest the $5,000 that would be left over after eliminating your mortgage balance.
Finally, since you could tax-deduct your mortgage payments, assuming a marginal tax rate (your income tax rate if you had earned one more dollar of taxable income) of 25 percent, your net after tax cost of your mortgage payment was = $900 X .75= $675. I would then arrange an automatic transfer to my mutual fund from my checking account each month equal to $675. By so doing, I would have then disciplined myself to save each month.
For other home owners who want to shorten their mortgage payment periods, all one needs is discipline. First, make sure your mortgage has no prepayment penalty. Then, use a portion of your annual bonus to reduce your mortgage loan balance. Mark that check "partial prepayment" and send it in with your mortgage check.
Another way is to increase the amount your monthly mortgage check by what you can afford and note on the check the prepayment amount. I recommend that you speak with a customer rep at your mortgage firm to make certain you follow their procedures for prepayments.
The benefits of any early payoff can be huge. For a 30-year, 7 percent mortgage, if you pay $100 extra per month beginning in the first month, you can shorten your mortgage period by over 7 years. To learn more, check out www.mtgprofessor.com.
Got a question? You may e-mail Greg at greg29803@gmail.com
Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience.
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