Making extra payments on your mortgage? Many people do — they’re anxious to get that mortgage paid down as quick as they can. But especially with interest rates this low, that might not be the best place to put that next dollar.
So what are the top five reasons to postpone that mortgage burning party?
1. Your emergency fund is on the scrawny side. Before you send another extra dollar to your mortgage company, beef up your cash reserves. Sure, you are saving more in interest than you’re earning in your bank account, but what happens if you lose your job? You can’t rip out your bathtub and sell it on eBay for grocery money. And the bank isn’t likely to loan you the money back while you’re unemployed.
Likewise, if you’re still saving for retirement, putting that extra money toward your retirement savings is a smart move. You’ll be taking advantage of the power of compounding by putting the money to work for you sooner. You get an extra bonus if adding to your retirement savings garners you more of an employer match.
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2. You are carrying other debt, like credit card debt or a car loan. Those consumer loans should be paid down first. It’s likely your credit card interest is higher than your mortgage rate, and your mortgage interest may offer you a tax deduction that you’re not going to get from a credit card or car loan. Work on reducing your consumer debt to zero before even considering paying down your mortgage.
3. Capture the arbitrage. Remember not that long ago when online banks were paying 3.5%? That’s about what you can get a 30-year fixed mortgage for these days. Economies are cyclical; it’s only a matter of time until those deposit rates return, and go even higher. And when they do, you’ll be glad to have your money earning more in the bank than the bank is charging you on your mortgage. Imagine the scenario where you could pay off your mortgage if you wanted to, but instead watch the interest you’re earning outpace the interest you’re paying.
4. Those extra dollars could be put to use elsewhere. Perhaps your career could use a boost from some coaching or certifications? The additional money you’ll earn year after year from investing in your working future may return loads more than the savings on your mortgage.
5. Keeping a mortgage is a hedge against inflation. I remember when my mother-in-law paid off her mortgage years ago. She jokingly wondered what she would do with the whopping extra $92 a month she now had. Chances are, when they were a young married couple with a few children, that $92 seemed like a fortune. But years later, it was peanuts. That’s what will happen to your mortgage, too. As prices all around you go up, you can enjoy having that one bill that will remain the same. That payment will become cheaper and cheaper, relatively speaking, as time goes on.
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So when should you pay extra on your mortgage?
Certainly keeping a mortgage is not for everyone. If your DNA is so debt-averse that you can’t sleep at night knowing you owe someone (not exactly a bad character trait to have), paying off your mortgage can give you peace of mind and a good night’s sleep. When you have all of the other aspects of your financial plan in place — your emergency fund is stocked, you’ve saved enough for retirement or are well on your way, you are carrying no other debt — then go ahead and make those payments if it helps you sleep better at night.
Planning to sell your underwater or just-treading-water house in the not too distant future? You might be in a position to need to bring money to the closing table or walk away with a small amount of cash, not leaving much for the down payment on your next home. In that case, paying extra on your mortgage for a period of time prior to the sale may yield a bit more return than simply stashing the savings.
Especially if you have been able to take advantage of the historically low interest rates we’ve experienced for the past few years, bypassing those extra mortgage payments can gain you more ground in other areas. But those dollars you could have put toward your mortgage and didn’t are only valuable to you if you actually do something useful with them. Letting them be mindlessly consumed by lifestyle spending is the worst alternative to paying down your principal. As with all things in life, being purposeful with your money is the key to being successful.
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