Payment Options

There’s a comforting feeling that comes with the notion that the house you live in will some day be fully and truly all yours – nothing further to owe your mortgage lender.

But while the inclination may be strong to prepay extra monies toward your mortgage, with the goal of saving thousands in mortgage interest and owning your home outright quicker, many experts caution that those extra funds could be put to better use via different investment vehicles.

Paying down the principal early may be a reassuring thought that can lower your stress level and increase financial flexibility, says Larry Luxenberg, a portfolio manager with Lexington Avenue Capital Management in New City, N.Y. For someone in a secure financial position, “paying off the mortgage may provide a higher after-tax return on investment than alternative fixed-income investments,” Luxenberg says. “However, if your financial situation is shaky, it may make more sense to keep a liquid reserve instead of sinking excess funds into prepaying a mortgage.”

When you prepay the mortgage, “you don’t have that money under your control any more,” says Pete D’Arruda, president of Capital Financial Advisory Group, Cary, N.C. “You are, in effect, receiving a negative interest rate on the money tied up in the home’s equity,” he says. ‘You get a zero-percent return on money you don’t have any more, plus throw in the fact that inflation today is at least three percent, so everything is costing more.”

What’s more, if you itemize income tax deductions and your mortgage interest if fully deductible, paying off your mortgage early will mean reduced interest deductions and, thus, higher income taxes. Usually, for every $3 you pay in mortgage interest, you save about $1, on average, in taxes.

If you’re lucky enough to have extra funds to put toward your mortgage, it may be wiser to keep that money in a liquid account. This way, you’ll have emergency funds in reserve, and if you decide to pay off the house in the future, you’ll have those funds available.

According to Ethan Ewing, president of Bills.com, mortgage prepayments should only be considered if you’re already funding other key investments such as retirement and college savings. Mortgage debt is generally the lowest interest rate loan you’ll get, so if you can earn greater than a 5-percent yield on your cash, and your interest rate is 5 percent or less, then it makes sense to invest that additional cash elsewhere.

In general, most people are better of investing in broad-based retirement vehicles with tax-sheltered income, with puts Roth and traditional IRAs and 401(k)s at the top of the list, especially for those who receive a corporate match on their retirement accounts. Mutual funds are also much safer for most investors than individual stocks and bonds and can yield a much higher rate of return than CDs.

If you’re going to devote those extra dollars to your nest egg, try to invest at least 10 percent of your gross income in one or more retirement funds. But if you have any outstanding credit card debt, “you should pay that off first,” says Kevin Amolsch, president of Pine Financial Group, Inc. in Wheat Ridge, Colo. “Credit card rates are normally pretty high, so unless you know of a secure investment that pays a higher rate, it makes sense to eliminate that debt first.”