To pay or not to pay…down the mortgage…that is the question!

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Now that you have received your third round of stimulus payments, perhaps you aren’t spending as much on going out for dinner, travel, and entertainment, and given that bank savings rates are minuscule – the question becomes what should you do with your extra money?

If you’re considering paying extra on your mortgage, there are two options:  making extra payments monthly or paying off the mortgage in a lump sum.  Firstly, we will discuss paying extra monthly.  Then we will cover the lump sum payoff option.

Some clients have asked “should I use the “extra” money to pay down the principal on my home mortgage?”  Well, the answer is… it depends! It depends on your particular situation and the answer that you come up with when you do the math.

First some basics: Most mortgages today allow you to pay extra on your principal each month or as a one-time extra principal payment, without a “prepayment” penalty.  Of course, it is always best to check first to confirm that your mortgage doesn’t have a prepayment penalty.

There are two main parts of a mortgage payment: principal and interest. Principal is the actual amount you borrowed, or your outstanding balance and interest is the amount you pay to the financial institution that lent you the money. At the start of the loan, the amount of interest you pay is much larger than the amount of principal that is paid down. By the time you reach your final payments, most of your payment is going toward principal and only a small portion is going toward interest. The process of balancing out the principal and interest each month to keep your monthly payments the same is called amortization.

If you make extra principal payments early in your loan, this will potentially save you thousands of dollars over the life of the loan.  However, if you are in the later stages of your loan, there may not be enough interest savings to make it worthwhile by paying down the principal.

This may sound like a great idea, but for some people it may not be the best option. That’s because there’s an opportunity cost involved: if you pay extra toward your principal balance, then you can’t use that money for anything else nor can you invest that money elsewhere for growth.

Let’s look at a few areas that may represent better uses of your money:

Payoff your higher interest rate debt. It may not make sense to pay off a 3% mortgage if you have credit cards or other loans with higher interest rates.

Funding your 401(k). If your employer offers a match to your 401(k) contribution, then ensuring that you’re getting the full match amount is an absolute must. If you’re not maximizing your contributions to get every possible match dollar, then you’re leaving money for your retirement on the table. You may potentially earn more from your 401(k) over the long term than you may save by paying extra on your mortgage principal.

Funding your emergency account. Making sure you have sufficient reserves in the bank to meet unexpected emergencies should they arise. Financial planning guidelines suggest 6-12 months of household or budgeted expenses. However, we recommend having more “pillow money” which may help you sleep better at night knowing you have more than adequate reserves in the bank.

If your monthly budget is too tight, then paying down extra principal may not make the most sense. Pay your monthly bills first and make sure your budget isn’t too tight. Next, you may want to protect yourself making sure you have adequate, life, health, disability, and property insurance, especially if you have financial dependents.

Under the right circumstances, making extra principal payments on your mortgage can result in significant savings and can help you to pay off your mortgage ahead of schedule.

Paying off your mortgage in a lump sum is a question that we hear often.  “Let’s do the math” is our typical response.  Let’s say that you have $100,000 in the bank with a $50,000 mortgage balance.  How much are you earning in the bank versus how much are you paying in interest on the mortgage?  If you are paying 3% on the mortgage and could invest at a modest 5% or 6% rate, the math seems to indicates that paying off the mortgage makes mathematical sense. 

As always, if you’d like to discuss your particular situation, call our office and one of our advisors can give you more details.

Massey & Associates, Inc is an independent financial services firm that utilizes a variety of investment and insurance products. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Massey & Associates, Inc are not affiliated companies. Investing involves risk, including the potential loss of principal. Any references to protection benefits, safety, security, lifetime income, etc generally refer to fixed insurance products, never securities or investment products. Insurance and annuity product guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Our firm is not affiliated with or endorsed by the U.S. Government or any governmental agency. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. 892793 – 4/21

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