Why you should (and shouldn't) pay off your mortgage
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"Do the math," says Jon Hanson, an author and speaker on personal finance based in Columbus, Ohio. "The best reason" to pay off a mortgage, he says, "is just having the emotional peace of mind."Skip to next paragraph
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Here's how the math works in the case of a couple with a 25 percent federal tax rate and a 6 percent rate on their mortgage. Because mortgage interest is tax-deductible, their effective interest rate, with the tax-benefit figured in, is 4.5 percent. If stocks return about 7 percent a year - which some analysts see as a reasonable forecast - the couple stands to gain by investing rather than paying down the mortgage. But much of the financial benefit vanishes if the investment isn't tax-sheltered.
And be careful with bonds, experts say. If they aren't held in a tax-sheltered account, Treasury notes earning 5 percent would net only 3.75 percent for the couple, after taxes.
Often financial experts refer to certain loans as "good debt." A mortgage leads toward home ownership, and a student loan can pave the way to a high-paying career.
On the other hand, "I don't think it can ever be considered 'good debt' unless you can actually show a return on it," says Mr. Hanson, author of "Good Debt, Bad Debt."
He warns that the tax advantages of a home mortgage, while real, may not be as big as people think.
The standard deduction on federal taxes for a married couple filing jointly, for example, is $10,300. The interest paid on a $200,000 loan might not be much more than that in a given year. So for households that don't have other deductions that approach $10,300, the after-tax mortgage rate may be similar to the pretax mortgage rate.
The math may be arcane, but doing it can bring rewards for young and old alike. "Managing the last few pennies out of a dollar, for a lot of people, is going to mean the difference between comfort and a tight belt," says Miller, author of "Retire Dollar Smart."
For a young couple, with the option of tucking money into a tax-sheltered retirement account, "it doesn't make much sense to pay down your mortgage," says Greg McBride, a senior financial analyst at Bankrate.com.
One exception, he says, is that people might want to pay down a high-interest "jumbo" loan. Once the debt falls below $417,000, it can be converted to a lower-rate conforming loan.
Experts offer some other nuggets:
• Don't fall further into debt. Many have borrowed against their home equity, but used the cash for spending rather than for investing or discharging other debts.
• Have a cushion in case home prices don't keep rising. If you need to sell your home, you'll have to cover transaction costs (such as broker's commission) as well as pay off your loan. The cushion may come from investment dollars or from paying down mortgage debt.
• Seek professional help if the choices seem hard to fathom, but find a seasoned adviser.
• Consider locking in a low-interest rate. Whether you're paying down your mortgage or not, adjustable-rate mortgages are ratcheting upward. Refinancing with a fixed rate may make sense.