Owning a home directly is a dream that many Americans share. With a mortgage can be an enormous burden, and pay it out, can be the first item on your financial to-do list. But competing with the desire to own your home free and clear is your need to invest for retirement, your child's school education, or some other goal. Putting extra cash toward one of these goals may mean sacrificing another. So how do you choose?
Evaluation of the opportunity costs
Selecting between prepay your mortgage and invest your extra cash is not easy, because each option has advantages and disadvantages. But you can start to consider what you will achieve financial select one option against what you have to give up. In economic terms this is known as the evaluation of opportunity costs.
Here is an example. Suppose you have a $ 300,000 balance and 20 years left on your 30-year mortgage and you pay 6.25% interest. If you were to put an extra $ 400 toward your mortgage each month, you will save approximately $ 62,000 in interest and pay your loan almost six years earlier.
By making extra payments and save all that interest, you will definitely be getting a lot of financial ground. But before you decide to prepay your mortgage, you still have to consider what you can give up by making it-the opportunity to potentially profit more from investing.
To determine whether you would come out ahead if you invested your extra cash, start by looking at the after-tax returns you can expect from prepay your mortgage. This is generally less than the interest you pay on your mortgage when you take into account any tax credits you receive for mortgage interest. Once you've calculated that figure, comparing it to the after-tax return you could receive by investing your extra cash.
For example, after-tax cost of a 6.25% mortgage be approximately 4.5% if you were 28% tax bracket and were able to deduct interest expenses on your federal tax return (after tax costs could be even lower if you were also able to deduct interest payments on your state tax return). Did you receive a higher after-tax return if you invested your money instead of prepay your mortgage?
Remember that the return you receive is directly related to the investments you choose. Investments with potential for greater returns can expose you to greater risk, so consider this when making your decision.
Other points to consider
While the evaluation of opportunity costs is important, you also need to balance many factors. The following list of questions can help you decide which option is best for you, visit http://kenhimmler.com/ of several strategies.
• What is your mortgage interest rate? The lower the interest rate on your mortgage, the greater potential to receive a better return by investing.
• Does your mortgage have a prepayment penalty? Most mortgages are not, but check before extra payments.
• How long do you plan to stay in your home? The main advantage of prepay your mortgage is the amount of interest you save in the long run if you plan to move soon, there is less value in putting more money toward your mortgage.
• Want discipline to invest your extra cash rather than use it? If not, you may be better off with additional mortgage payments.
• Do you have an emergency account to cover unexpected expenses? It makes no sense to make extra mortgage payments now if you want to be forced to borrow money at a higher rate later. And remember that if your financial situation changes, if you do lose your job or suffer a disability, for example, you may have more problems with borrowing against your home equity.
• How comfortable are you with debt? If you worry endlessly about it, give the emotional benefits of paying off your mortgage extra consideration.
• Are you saddled with high balances on credit cards or personal loans? If so, it is often better to pay that debt first. The interest rate on consumer debt is not deductible and are often much higher than both your mortgage interest rate or return, you can receive on your investments.
• Are you currently paying mortgage insurance? If you are putting extra toward your mortgage until you have achieved at least 20% equity in your home may make sense.
• How will prepaying your mortgage affect your overall tax situation? For example, prepaying your mortgage (thus reducing your mortgage interest) may affect your ability to itemize deductions (this is especially true in the early years of your mortgage when you probably pay more in interest).
• Have you saved enough for retirement? If you have not, consider contributing the maximum each year to tax-favored retirement accounts before prepaying your mortgage. This is especially important if you receive a generous employer match. For example, you save 6% of your income, an employer match of 50% of what you contribute (ie 3% of your income) potentially add thousands of extra dollars to your retirement account each year. Prepaying your mortgage may not be the savviest financial move if it means waiving that match or short changing your retirement.
The middle ground
If you need to invest for an important goal, but you also want the satisfaction of paying down your mortgage, there is no reason you can not do both. It is as simple as allocating a portion of your available cash to one goal, and put the rest against another. Even small adjustments can make a difference. For example, you can potentially shave years from your mortgage by consistently doing every other week instead of monthly mortgage payments or by paying all year-end bonus or reimbursement of taxes on your mortgage principal.
And remember, whatever you decide now, you can always reprioritize your goals later to keep up with changes in your circumstances, market conditions and interest rates.
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