You’ve likely dreamed of the day that you would own your home free and clear. If you want to see that day sooner rather than later, you know that making additional principal payments is your route to mortgage freedom. While there are several benefits of paying additional principal on your mortgage, there are several variables that determine whether it's the right choice for your financial situation right now.
What Does Your Debt Look Like?
If you are carrying a balance on credit cards or auto loans, it’s probably a good idea you pay those off first for several reasons. While an auto loan is an installment loan and provides a good mix of credit on your credit report, your interest is spent financing a depreciating object. A home is highly likely to appreciate in value.
Credit cards typically carry a much higher interest rate than your mortgage and you don't get to use that interest as a tax deduction. Make paying off that debt your first priority.
Do You Have Emergency Savings?
Life is unpredictable. Do you have a good financial cushion in place in the case of a job loss, major medical expense, etc.? Most financial experts suggest having reserves (that you can access without penalty) to cover at least six months of expenses in the case of an emergency.
What’s the “Real” Interest Rate on Your Mortgage?
Remember that there are several tax benefits to having a mortgage. If you have a fixed-rate mortgage at 4% interest, are in the 25% tax bracket, and qualify for mortgage interest deduction, your interest rate equates to nearly 3%. Odds are high that you would make more than 3% on investments.
How Do Investment Earnings Compare to Your Mortgage Interest Rate?
If your mortgage interest rate is between 3-4.5% (after taking into account mortgage interest deductions) and your investments earn 5%, it doesn’t make sense to pour additional principal into your mortgage. If your mortgage interest rate is 3.5% and your investments earn 5%, your spread is 1.5%. The higher and more stable return you can make on your investments, the better.
What Does Your Retirement Portfolio Include?
Some financial advisors say a good rule of thumb is that your investments and savings should be at least double the value of your home, if the home is paid off. If your retirement savings fall short, investing could be the better route.
While paying off your mortgage may give you peace of mind, investing additional funds or paying off other debts could give you a greater sense of financial security prior to paying down your mortgage.