Summary List Placement
Debt can often be a thorn in your side on the path to building wealth, but it’s not all bad.
Still, if you’re a homeowner with a mortgage, you’ve likely weighed the decision to pay it off early, if you can afford to. It’s a worthy goal to be free and clear of all debt, but is it the right choice if you’re trying to optimize your every dollar?
A financial planner’s recommendations
We consulted Brian Fry, a certified financial planner who founded Safe Landing Financial. He said the answer really depends on the specifics of the situation, but generally the biggest factor in deciding whether to pay off a mortgage early or invest your extra cash from a windfall, salary raise, or some other source is the interest rate.
Here are his high-level recommendations. Scroll down for the full set of assumptions he used.
Best action: Refinance and invest more aggressively, because a 15-year fixed mortgage with a rate of 3.19% is much lower than the market’s expected rate of return.
Second-best action: Refinance and pay the mortgage aggressively. If the homeowner doesn’t agree with long-term investment-return estimates and would rather act more conservatively, they can pay off the mortgage and then invest and still come out OK.
Third-best action: Don’t refinance and pay the mortgage more aggressively. The homeowner will be debt-free 99 months sooner by putting an extra $24,000 a year toward the loan balance.
Worst action: Don’t refinance, don’t invest, and spend the extra cash instead. If the homeowner did not refinance and decided to spend the money, they would not have extra retirement savings, if that’s their goal.
Second-worst action: Don’t refinance, and still invest the extra cash. A 5.84% interest rate on the loan is higher than the market’s expected rate of return. If the homeowner is locked into a higher interest rate, it’s best to pay off the debt first.
The bottom line: Look at interest rates
If the rate on your mortgage is higher than what you might make by investing the cash, it’s often better to pay down your debt before investing more, Fry said.
That is, unless you consider refinancing to secure a lower rate, he said. In fact, refinancing can be a good option whether or not you ultimately decide to pay your mortgage aggressively. Interest rates fluctuate and they’re currently at historic lows, so be sure you shop around before making a decision or running your own numbers.
But Fry said it’s also crucial to look at how far you are from retirement, how long you plan to stay in the home, whether you have other high-interest debt, the possibility of tax deductions, and the status of your emergency fund and retirement savings. There are non-financial factors to think about as well.
“It’s really important to have a good understanding of what you’re trying to accomplish before determining the best …read more
Source:: Business Insider