Question: This is related to the post by the fellow who was wondering if he should > pay off his credit card bills or use the money to play the market > instead. My husband and I refinanced our house last year, going from an > 8.5% 30-year mortgage to a 6.5% 15-year. Because we have paid off our > credit card bills and have no other debt, I have an extra $500 a month > in the budget that I could apply to paying down the principal early. > But I wonder if it would be better to invest the money rather than pay > off a relatively low-interest loan? (We have emergency savings and > retirement funds, and no dependents, so we don’t have an urgent need for > the money elsewhere.)
> I’d like to retire when I’m 55 (8 years from now) and if I applied the > money to the mortgage, the house would be completely paid for by that > time. That’s very attractive to me, but recent financial advice that > I’ve read says don’t pay off a low-interest mortgage. What does the > group think?
Answer: Hi Linda,
I faced almost exactly the same question ten years ago with a 15-year refinance at 6.8%. The answer for me was to keep the loan and not make pre-payments or just pay it off with the extra cash I had saved. The reasons were two: that 6.8% loan was costing me only 4.6% after I took my tax deduction and even a conservative investment portfolio would bring me an 8% return; and, that if I ever needed cash for a family emergency or loosing a job my reserves would be low since I would be house rich and cash poor. Of course, I could take out a high interest rate home loan in the latter case, but that puts your home at risk if you cannot repay it.
The decision, in retrospect, turned out even better than I hoped because what would have been prepayments went instead to some boring old mutual funds that have averaged 20% to 30% a year for the last 4-1/2 years. That put me thousands ahead of the game. Now, the story is different: I have paid off so much of my loan, that I now take a standard deduction on my taxes. The last time I did the math, it was about break even for paying my loan off early. Available cash for emergencies is now the only consideration and that is also close to break even.
I suggest you do the math for your own situation. It can be simpler than it sounds. Just redo last year’s income taxes (state and federal) in the margin of your forms and pretend you had prepaid your loan and compare that to how well the prepaid amount would have done in your current investment portfolio. Figuring a partial prepayment can be a little more complicated. Then try to figure out what you would have done if one of you had lost your job during the year and how you would have come up with the cash to live on for six months (or whatever period you decide is best for you). Good luck, — John
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