If you have, say, a 6 percent mortgage, paying down the mortgage generates an after-tax return of around 4 percent. Image: GRASSY LOOK/Shutterstock.com
If you are trying to cut down on debt—either in the runup to retirement or just to get rid of it—a common place to start is any credit card balances, which have high interest rates and offer no tax shelter.
If you have no credit card debt—or only an easily manageable amount—your biggest debt might be the balance on your mortgage. Should you pay that off, or at least down? Here are some things to consider:
The numbers side. If you have, say, a 6 percent mortgage, paying down the mortgage generates an after-tax return of around 4 percent. The exact number will depend upon your tax bracket, your state and local income tax rates, and whether you owe the alternative minimum tax.
Does it make sense to pay down a 6 percent mortgage for a risk-free 4 percent return, after-tax? Yes, if you have large amounts of money in money market funds and other accounts paying very little yield now. Otherwise, you have to decide whether to prepay your mortgage or invest elsewhere, in hopes of earning annualized returns higher than 4 percent, after-tax.
The emotional side. Some people, especially retirees and pre-retirees, simply want to be out from under a mortgage while living on a fixed income. Not having a mortgage may increase your feeling of financial security after you retire. If you’re in that category, paying down your mortgage might be a good decision.
If you don’t have sufficient cash sitting around to pay off your mortgage at once, you can accomplish the same goal more gradually. By paying an extra amount of principal each month, you can pay off a mortgage in half the time. Each month, pay an additional amount equal to the next month’s principal payment. Get an amortization schedule to see exactly how much to pay. Then each succeeding month, add the following month’s principal amount. Your interest savings will be substantial, as well.
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