Paying off mortgage just one option

By Sandra Block
USA Today

Mortgage burnings, like barn raisings and sock hops, are a relic of another era. In our mobile society, most of us don't stay in our homes long enough to pay off a 30-year mortgage. And even if you can afford to retire your mortgage early, many financial planners believe there are better ways to invest your extra cash.

Still, there's an unquantifiable sense of security that comes from owning your home. In addition, making extra payments on your mortgage will save you thousands of dollars. On a $200,000 mortgage, making just one extra payment a year could save you more than $65,000.

Those are powerful numbers. And if you've been burned by the stock market in the past couple of years, you may feel your home offers a much better return.

There are equally powerful arguments against paying off a mortgage early. Long-term mortgage rates are hovering around 7 percent. If you deduct mortgage interest from your taxes and you're in the 27 percent tax bracket, the actual rate is closer to 5.1 percent. This means any investment that earns more than 5.1 percent will provide a better return on your money.

There are other ways to invest your extra cash that will provide even more security than a paid-off mortgage, says Keith Gumbinger, vice president of mortgage tracker HSH Associates. Some examples:

• Your retirement. Before you put extra money toward your mortgage, make sure you've taken full advantage of tax-advantaged retirement savings plans, such as your 401(k) and an individual retirement account. Owning your own home won't provide much retirement security if you can't afford to buy groceries.

• Insurance. If you have dependents, you need life insurance. Make sure your policy provides enough money to cover your family's mortgage, living expenses and education costs. Disability insurance, while more expensive, is also a good idea. Your family will be protected if you're unable to work for a long period of time.

• An emergency fund. Most financial advisers believe you should have enough in savings to cover your expenses for six months to a year.

And you shouldn't even think about prepaying your mortgage if you have other high-cost debts. Credit card interest rates are more than twice that of most home mortgages. Extra cash should go toward paying off the balance.

Paying off a mortgage early benefits some homeowners more than others, says Greg McBride, financial analyst for Bankrate.com. Who stands to benefit the most:

• Homeowners who don't deduct mortgage interest. If your mortgage is small, your interest may not exceed the standard deduction the IRS gives non-itemizing taxpayers. Without the tax break, the actual cost of your mortgage is higher. Paying it off early makes sense.

• Homeowners who pay private mortgage insurance. Lenders typically charge PMI to borrowers with less than 20 percent equity in their homes. If you're close to 20 percent, making extra payments could put you over the top. Eliminating PMI will reduce your monthly payments, so you'll get an immediate return on your investment, McBride says.

Many lenders offer products designed to help you pay off your mortgage early. For a fee, they'll arrange to have the money withdrawn from your bank account twice a month. Each payment will be half your regular monthly payment. But because there are 26 biweekly periods in a year, you end up making the equivalent of 13 monthly payments.

Those arrangements are convenient, but you can set up your own accelerated schedule for free, says Dan Gilbert, CEO of Quicken Loans. One method is to take your monthly mortgage payment, divide it by 12, and add that amount to each monthly payment. Or, simply make an extra mortgage payment at the end of the year.

Whichever method you choose, make sure you specify that the extra payment should be applied to the principal on your mortgage, Gumbinger says.

Finally, before stepping up your payments, make sure your mortgage agreement contains no penalties for early payment. Most conventional mortgages have no such restrictions, Gumbinger says. Some adjustable-rate mortgages contain penalty clauses, but they're usually limited to large pay-downs early in the mortgage.