One of the questions frequently asked by clients is whether they should save more for retirement or add funds to their monthly mortgage payments to pay off the debt sooner. While each circumstance is unique, let me share some general guidance on the subject.
If you examine the payment schedule for a typical 30-year mortgage, you’ll note that the majority of the payments in the early years (years 1-7) are applied to interest and that this reverses in the later years, when the majority is applied to principal. This is not an accident: Lending institutions know that, on average, mortgages are held approximately seven years, replaced by either a refinancing or the sale of the house. So, the lender takes the interest early so they get paid most of the interest even if the mortgage is satisfied after six or seven years.
So, if you have five to eight years left on your mortgage, you have probably already paid the vast majority of all the interest on the loan. Therefore, paying the loan off early won’t save you as much as you think in interest; if your mortgage carries a stated rate of 4 percent, you will likely save less than 2 percent a year by paying it off early that late in the cycle.
If one assumes that you can earn more than 2 percent on your investments, then adding to savings works better than accelerating your mortgage payments. Also, if you itemize deductions on your federal tax return, the interest on house-related debt is deductible, so the net interest cost to you is even less, which makes additional savings even more attractive.
That being said, there are a couple of reasons why the reverse might make sense. Let’s say, for instance, that the financial markets are struggling and as a result, you would be better off applying the money to the mortgage than putting it in the market, only to risk losing it. Second, there is a strong psychological effect to becoming debt free and sometimes that is worth favoring debt elimination over additional savings. Finally, some people seem to have more discipline when it comes to paying bills than saving – if that’s you, then pay away!
Obviously, these decisions have to be made in the context of your personal situation. There are many factors to be taken into consideration when making such a decision. Speak with a trusted financial professional to weigh your options and discuss your goals.
Frederic “Ric” Schilling is a Florida native, born in Jacksonville, Fl. Ric is President of Senior Guardians of America, a local North Florida firm specializing in tax reduction, long term illness planning, asset protection, probate avoidance and life income planning. Ric is a National Speaker and Advocate on Senior Issues and has been featured by the Florida Times Union and WJXT, TV-4 in Jacksonville as an authority on Estate Planning and Retirement Issues. Senior Guardians has an A+ rating with the Better Business Bureau and is a member in excellent standing with the National Ethics Association. Contact Frederic: 904-371-3302 or 888-891-3381 Please visit: www.seniorguardian.comThis article is not intended to give tax or legal advice. Securities offered through Center Street Securities, Inc. (CSS), a registered Broker-Dealer and Member of FINRA & SIPC. Senior Guardians is independent of CSS.