In today’s Office Hours, Eric answers Sara’s question: Should I be trying to pay off my mortgage early with extra payments or put that money to a different use?
Of course, this is another case of “it depends.” Listen to Eric explain when it may be a good idea to invest that extra money and when it’s okay to make that mortgage number start falling.
Have a question? Tweet it to us at @BrotmanPlanning and it may be answered in a future episode of Office Hours!
[00:00:00] Eric Brotman: This is Eric Brotman, the host of Don’t Retire… Graduate!: The podcast that teaches you how to advance into retirement, rather than retreating. Welcome to Office Hours, where we answer listeners’ questions about personal finance, retirement readiness, and more. We received a question from Sara, who asks, should I be trying to pay off my mortgage early with extra payments or put that money to a different use?
And Sara, like so many of the great questions we get, first of all, thank you. The answer is, it depends. And I know that’s a frustrating answer to get, you want this magic solution. But the reality is it’s going to depend on what your other situation, your other income and financial means are. If you have no debt other than your mortgage and you want to have the mortgage paid down, simply because it, it feels good psychologically far be it for me to tell you that that’s a bad idea, despite the fact that mortgages are inexpensive and that, you know, investment returns might be greater than that and so forth. There’s lots of people who think, oh, I should just keep my mortgage at 3% and go earn 6% in my portfolio.
The reality is that portfolios, which are generally more volatile and we’ll go up and down, there’s a lot of risk in doing that. And I don’t know too many people who would ever suggest particularly professionals who would ever suggest that you go out and specifically borrow money against your house to invest. In fact, I would argue that’s generally a terrible idea.
So why is it that we then might suggest, well, don’t prepay your mortgage, use your money for other things and try and get a better return. The fact is that that mortgage debt is usually leverage. It’s usually good debt and it’s often fixed and it’s often low rate. And in some cases it’s even tax deductible.
So there’s lots of reasons why a mortgage really isn’t bad debt in most cases. So if you have other debt, if you have a mortgage, but you also have a car loan or a student loan or credit cards or other stuff, typically a mortgage is the last thing you want to prepay because it’s usually the lowest rate debt that you have.
If you’ve got a mortgage at three and a half percent, and you’ve got a credit card at 14%, there’s lots of people who think, oh, I should pay my mortgage first because it’s the bigger note. But the reality is it’s the interest rate that matters more than the. So if you have any debt other than your mortgage pay those first. If the mortgage is the only debt you have, Sara, then I think it’s perfectly fine to make some extra payments as long as you have an emergency fund already established. And as long as you’re already hitting your financial independence goals.
So here’s what I mean: if you earn a hundred thousand dollars. And you know that you’re, you’re putting away X dollars and you’re living on, let’s say after taxes, $60,000, you’re living on $5,000 a month. If you have an emergency fund of somewhere between three and six months of that, so call it 15 to $30,000 in the bank, then it’s much, much safer to start sending extra money to the mortgage than if your bank account is, is on fumes, and if you run out of cash at the end of every month, waiting for your next paycheck. At the same time, I would hate to see you pay down the mortgage more but not take advantage of things like your company’s 401k or health savings accounts or other types of tax favored investment options. Roth IRAs. There’s so many different ways to, to park money and to do some tax planning that that also plays a role.
So I know I gave you the definite maybe as an answer. But it’s a definite, maybe you have to look at your balance sheet and you have to look at your income statement. And if you have a financial advisor, call him or her and walk through it and stress test this. You know, what makes more sense? If paying off your debt is the number one priority that you have and the only debt you have is your mortgage, you can either pay access toward it, or you can refinance it to something that shorter term. If you’re three years into a 30 year, And this is your highest priority, you might find a 10 or 15 year mortgage out there that will not only have a lower interest rate, but that will get you completely debt free sooner.
It’s not for everyone. And the challenge with doing that is that the payment isn’t optional, the payment becomes required every month. So understanding what your cashflow is, how predictable your job earnings are, whether you’re in a one income household or a two income house. All of those things play a role into what makes the best use of a specific dollar.
So I’m sorry, I couldn’t give you a more definitive answer. I would tell you to talk to your financial advisor or your CPA and just take a look at what your money is doing for you and whether that’s the best place to put it. In general, I’m with you. I like to have a smaller mortgage balance, too. But sometimes there are other things that need to take precedence.
So Sara, thanks for your question. If you’d like to send us a question, which we might answer in a future episode of office hours, post it on our Facebook page or tweet us at @BrotmanPlanning. If you like, what you hear, please subscribe to our podcast and leave a review on apple podcasts or wherever you listen to your favorite shows.
Please also check out our books, workbooks and online financial literacy resources at brotmanmedia.com. Thanks for coming to office hours. Be sure to tune in for new content every Thursday. For now, this is your host, Eric Brotman, reminding you don’t retire. Graduate.
