The clear advantages of
paying off your mortgage as quickly as possible have changed quite a bit over
the past few years. The urgency to pay it off has somewhat diminished, as
interest rates have plummeted to historical lows. It's no longer the black and
white decision it was back when interest rates hovered between 6% and 9%, and
even the 11% to 13% we saw a couple of decades ago.
I am a
big proponent of paying down that ugly mortgage beast as soon as is practical.
But, before you go cutting a check to the bank, there is a pecking order of
financial priorities you need to address before you consider tackling your
mortgage.
In order
of importance, here are the places you need to put your financial attention
first:
Take The
Cards Off The Table: Pay off
all credit cards with high interest rates. Consider the huge discrepancy
between credit cards with interest rates of 13% – 23%, and a 4% mortgage
interest rate.
In Case
Of Emergency: You need to build an emergency fund, ideally 8-12 months of
living expenses. Yes, today's job market is improving, but if you suddenly find
yourself facing a layoff, you need to be prepared to sustain up to one year of
living expenses.
Build Up
For Retirement: Are you
able to make the maximum yearly contributions to your retirement accounts,
401K, IRA or an equivalent? Ask your accountant what the maximum allowable is
for you and go for it!
Get The
Kids To School: Ah yes,
the kids and college funds. Depending on how many children you have, how old
they are, and what type of college enrollment expectation they have, you need
to be making adequate contributions to those 529 plans or other college savings
accounts.
You May
Live A Long Time: My mom
is 97 this year, and my aunt just turned 100. So I am keenly aware that my
money could run out before my health runs down. Another priority investment you
need to be making each year is toward long-term health care insurance. It is
not as costly when you start it in your 30's or 40's. But, if you didn't get
around to it till your 50's, it will take a hit out of your budget each month.
Once you
have paid out and paid off all of the above...you are ready to begin to slay
the mortgage dragon with the remaining funds you have available.
Next
consideration is age. I believe that you should make efforts to pay off that
mortgage by the time you plan to retire. There is something very freeing about
the release of that last mortgage payment when you switch to a fixed income.
Plus, chances are you will not need the mortgage interest deduction.
One
important note that many people don't realize is that when you are into years
20 through 30 of your mortgage payment, you are paying very little actual
interest compared to what you paid in the early years. The banks have very
cunningly structured mortgages so that they get a large portion of their money
early on via interest sooner than later over the 30 years.
But How
Fast & How Much Should I Pay Down?
I always
suggest making that decision by counting backwards. If you want to retire and
be mortgage free by age 65, then calculate how much extra you will have to pay
monthly or yearly to pay it off by that date. You can use a mortgage calculator
that will help you do this – This blog has a great one you can access here.
Here's
an example: You bought your home at age 45 with a 30 year loan at 5%. You are
now 55 years old and you still owe $300,000 but plan to retire at 65. You are
going to need to up your current payment of approximately $1,650 a month to
approximately $2,650 a month till age 65. Not only will you get your mortgage
paid off ten years sooner, you will have saved almost $78,000 in interest!