A reader question, "My husband and I are thinking about paying off our mortgage early. We have a little more than $150,000 left and we have no debt. Other thoughts are to save the money for college for our two children that will be entering high school soon. My husband will be getting a good pension and I have a reasonable amount of money in my IRA. Does paying off the mortgage early make sense or should we invest it?" - Jennifer H.
Jennifer, great question that I have been hearing a lot lately. I think my view over time has changed a bit on this one. Today's investment rates are awful. You'd be lucky to get 2.5% by locking in your money for 5 years in a CD. The stock market has also been flat for a decade and real estate looks like dead money for some time. While I am a big believer in educating yourself and investing in companies that have great promise and execute well, individual stocks aren't for everybody.
You also have another factor to consider -- college financial aid. Typically, the equity in your home is not going to be considered for financial aid while any investments will become a factor and work against you. You didn't mention your interest rate, but if you've held the house for some time, it's likely that you are paying more than 6 percent interest rate. One of the first things you should consider is re-financing into a 15 year or less mortgage which may help you pay it off faster. If you are planning on paying extra it's likely you are able to handle the higher payments of a 15 year which will get you an ultra low rate.
Regardless of your comfort with your retirement funds, I would make sure to maximize any contributions to your 401(k) or IRA. You can only invest so much each year and you want to ensure you have plenty of retirement funds. If your employer offers matching funds, definitely take advantage, since its a guaranteed 100% return on whatever the match is.
After that, assuming you have sufficient rainy day funds, you have to make a decision based on the relative rate of your mortgage and what you can reasonably expect by investing your money. If you pay down your mortgage, make sure that you also get a line of credit that you can draw upon when you children get to college. 5 years from now, rates might be much higher and you'll kick yourself for not having locked in today's low for the next 10 years. The last thing you want to do is pay down your mortgage and then be forced to enter into a high rate loan.
Personally, at current mortgage interest rates, I'd be investing my money and not pay down the mortgage. When banks are lending money at 4% and the interest is tax deductible, it's hard to want to pay that off versus investing it. While things don't look so rosy in the U.S. and Europe, the economies of much of the rest of the world are moving forward and savvy investors will figure out where to put their money. However, I would recommend looking at the financial aid forms for a few colleges that you are interested in and study their formulas. Given the short time before your kids enter college, you may just opt for the safe bet, max out your retirement accounts and pay down your mortgage. Certainly, that's what you should do if you are going to invest in CDs or treasuries. You'll have fewer assets when it comes to financial aid and you'll have less debt, which is never a bad thing.
- Make sure you maximize your retirement funds first
- Pay down your mortgage if saving will negatively affect future financial aid
- If you opt to pay down your mortgage, make sure you have a line of credit locked in so that you can draw on it if necessary
- Given your time horizon for using the funds for college, you should not take much risk with your investments
Hope this helps.
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