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"Accelerating Mortgage Payment Versus Building Retirement Account"
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Article: "Should
you accelerate your mortgage payments at the expense of your retirement
"
By Andre Plessis
"Should You Accelerate Your Mortgage Payment or Build Your 401K Retirement Account?"
If, in order to pay off your mortgage earlier, you have to reduce
your contribution to your
In a recent research, economists posed this question: "If I have extra money for savings, should it go toward retirement or paying down my mortgage?"
They analyzed the tax advantages of itemizing deductions, mortgage rates and savings interest rates on retirement accounts. After examining those variables, the economists concluded, "About 38 percent of U.S. homeowners that are accelerating their mortgage payments instead of saving in tax-deferred accounts are making a bad decision."
The study, titled "The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings*," was conducted by Clemens Sialm of the University of Michigan's Ross School of Business, Gene Amromin of the Federal Reserve Bank of Chicago and Jennifer Huang of the University of Texas at Austin using Federal Reserve data.
One economist said the number of people who should be saving instead of paying off the mortgage is closer to 60% because the economists relied on conservative investment returns to calculate their findings but didn't take into account employers who match 401K contribution. Anyone with an employer match who is accelerating payment on his home mortgage at the expense of maxing out his tax-advantaged retirement account is MOST LIKELY TO BE MAKING a big mistake.
The typical match is 50% of the first 6% that someone puts on a 401K account. That means if you save 6% of your income, you get 3% additional saving from your employer, effectively a 50% return on your investment. That is like free money! If your 6% equals to $500 that means that your employer adds $250 to your retirement account.
Taking out money from your
Most people, have much better things to do with their money than to pay off a low-rate, and tax-deductible home mortgage.
I am certainly not against paying off a mortgage earlier. I like the idea of building equity fast. It feels more secure. Besides, the numbers can be quite impressive. Let's say you have a 30-year, $350,000 mortgage at 6.5% interest. Your monthly payment is $2,212.24.
 | By paying an extra $300 you could save $142,994.12 and pay off your mortgage in 21 years9 months. |
| By paying an extra $500 you could save $193,602.52 and pay off your mortgage in 18 years 7 months. |
That is quite impressive isn't it? What would you do with an extra $140,000 OR $190,000? I hope some great investment decisions. So why not go for that, right?
But anyone who really understands money would realize that the savings are not enough to justify adding more to your mortgage payment every month. For one thing, mortgages tend to be some of the cheapest money you can borrow, and the interest is usually tax deductible for most individuals. If you're in the 25% federal tax bracket, that 6% interest rate may be costing you as little as 4.5% if you itemize.
It seems that your money can earn better returns in the market compared with paying off low-rate debt. Based on historical returns, a mix of 60% stocks, 30% bonds and 10% cash would earn an average of more than 8% a year in most 20- to 30-year periods. It is not difficult to get a 8% to 12% return on many investments.
Most employers, typically match 50% of every dollar you put in up to 6% of your pay. If you're not contributing enough to at least get the full company match, you're leaving free money on the table, and missing out on an immediate 50% return on your investment.
The Advantage of Paying off Your Mortgage Earlier
All that said, it's not a bad idea to pay off your mortgage earlier. You should add an extra money every month toward the principal without sacrificing your retirement savings, that might be the appropriate decision. If you have an extra $300 per month you can save why not put half of it on your mortgage and half of it on your 401K. Maybe you put $200 on the 401K and $100 towards your principal. That will certainly save you a lot in interest payments and you will pay off your mortgage earlier.
While most of us have heard that it is better to pay off our home mortgage as fast as possible, both sides make some strong arguments for their case.
Here are some good reasons to payoff your mortgage early:
| You want to be 100% debt free. |
| You want to retire early. Once your mortgage is paid off, you can save up for retirement faster and eventually retire sooner. |
| You want a guaranteed rate of return. Paying off your mortgage guarantees you that savings rate. Investing in the stock market can never guarantee you anything. |
| If you are disciplined enough, once you have paid off your mortgage, you will invest the same amount of money into a retirement fund until you have enough to meet your retirement needs. Maybe you'll invest in other properties and create a passive income for your retirement. |
| You don't itemize but take the standard deduction. |
Here are some reasons for not Paying off Your Mortgage Early:
| You main financial goal is to obtain wealth. |
| You think you can get a better return in another investments. |
| You want to leverage your assets to help you achieve your goals more quickly. Using someone else's money is always better than using your own. |
| You are in a high tax bracket and this additional deduction lowers your income tax bracket as well as your taxes. |
So the decision to pay off or keep your mortgage as long as possible is up to you. What do you want to accomplish financially? Where do you want to be in the future and what type of legacy do you want to leave to your children?
To Your Success,
Andre Plessis
Andre Plessis
"The Mortgage Guru"
"A Mortgage Professional
whose primary goal is to provide the expertise, guidance and skills necessary to
obtain the best mortgage to meet your personal needs".
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