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Should You Pay Off Your Mortgage Early or Save?

Should you pay off your mortgage or pump up your savings and investments? Some people will tell you that, yes, you should absolutely pay off your mortgage. Others will say, no, you should put every penny in savings.

So which is it? Well, it depends because every situation is different. We recommend you assess the following:

Risk tolerance

What may seem like an adventure on the wild side for you may be a country stroll for someone else. If you’re willing to gamble, it may be possible to earn a higher rate of return with an investment over the long term than by paying off your mortgage.

You may want to keep your mortgage if you're after tax interest rate—what your mortgage really costs after you factor in your income tax deduction benefit, if any—is lower than the expected after-tax returns from your savings and investments.

In an oversimplified example, say you’re in the 28% tax bracket and can itemize your deductions. In this example, a 7.5% mortgage rate actually costs about 5.4%. That’s the figure an investment would have to beat for you to come out ahead by paying off your mortgage.

In making that decision, you’ll probably have to take a lump sum from your savings and investment portfolio. And, of course, there’s an opportunity cost involved in doing so.

Remember, too, that you’ll owe taxes on dividends and interest you earn on savings vehicles. Say you can earn a yield of 4% and are in that 28% tax bracket—your effective earning rate is actually more like 2.88%.

Financial situation

If you’re strapped for cash, in a precarious job situation or relationship, have health issues, or are uncertain about your finances for whatever reason, there’s no question: Increase your savings stockpile and stop worrying about paying off the mortgage.

Before staining, use a wood cleaner and a soft-bristled brush to remove dirt and mildew, or use a power washer, which you can rent for about $50 to $100 per day.

Emergency Savings

Most consumers lack adequate savings for contingencies like job loss. Putting money in savings, even with today’s very low returns, may be better than paying down a mortgage. Paying down might result in a better ’return‘ than an alternative investment, but houses are illiquid—they aren’t a source of immediate cash—especially in today’s market.

Life stage

If you’re near retirement, the idea of paying off your home can be comforting. After all, while you can live off a savings account, money market mutual fund, or equity investment, you sure can’t live in one.

Some advisers say it might be a better move not to pay down or pay off your mortgage depending, again, on the rate you’re paying. Mortgage rates are at historically low levels, averaging less than 5% for both 30-year and 15-year terms in early 2011.

Paying off your mortgage before you retire is a good idea but only if you have sufficient liquidity to do so. But, just because you have the liquidity to pay off your mortgage, should you?

If you're lucky enough to have the cash - maybe Aunt Bertha remembered you in her will - and have sufficient savings, then go for it!

But, don’t even think about paying off your mortgage or putting that money into potentially higher earning investments if you have credit card debt. Get rid of that first.

And if you’re working and are lucky enough to have a 401(k) account with an employer match, make sure you are taking full advantage of that savings vehicle. Then, if you are still looking at education expenses for your children, consider putting your extra money into a 529 college savings plan.

It doesn’t have to be either/or

If you have the liquidity but want to preserve flexibility, you can pay down your principal with an extra—and optional—$100 or $200 a month. Just make sure your lender applies any extra payments you make to the principal.

Decide what will make you rest easy at night and make your play. Just be sure you’ve planned for contingencies.

You may want to consider refinancing your home loan. If you can get a lower rate and/or shorten your term you'll save money in the long run and, possibly, free up additional money to put into savings. Our loan officers are experts in helping people save money on home loans. In fact, last year we saved people nearly $1 million in loan interest. Contact any of our home loan centers today and find out if we can save you some money.

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