IIt’s a great feeling to pay off debt, especially a large debt like your mortgage balance. Cleaning slate can have a number of great benefits: fewer monthly bills to pay, which means more money at the end of each month to be used for other needs and wants.
But should you use some of your savings to eliminate your mortgage, or rather use those funds to add to your investment and retirement savings portfolio?
The answer may depend on several important factors.
Allocate money for maximum benefit
There has been a long-standing debate between consumers and financial advisers about whether it is better to pay down debt or increase savings and investments. There really isn’t one clear answer that works for everyone in all areas.
For example, if your primary financial goal is to maximize wealth, adding more money to your investment or retirement portfolio may be the best alternative. Going this route can also help you keep a “cushion” for emergencies, as accessing money from a bank or brokerage account is usually much faster and easier than withdrawing money from. the equity in a property. (In fact, taking out a home equity loan will usually incur interest and closing costs ranging from 2% to 5% of the loan amount.)
But a mortgage payment can also eliminate one of the largest tax deductions available to homeowner consumers. In 2021, you can deduct interest charges up to a maximum of $ 750,000 of mortgage debt on your tax return. (However, this may require you to forgo the standard deduction of $ 12,400 as an individual filer, or $ 24,800 if you and your spouse are filing taxes jointly.)
On the other hand, paying off your mortgage could take a large monthly payment out of your budget. This, in turn, can give you more financial “wiggle room”, especially if you are facing a potential job loss or other reduction in income.
Good debt vs. bad debt
When deciding whether to take on more financial obligations or reduce your balance (s), it is important to know whether the money you are borrowing is “good” or “bad” debt. For example, loans for items that depreciate quickly, such as a new car, are generally considered bad debt.
Accumulating credit card balances is also negative, as the interest rate is typically in a range of 20% or more. So, unless you pay off your card balance every month, that high interest debt can grow exponentially over time, forcing you to pay a lot more for the purchases you make.
In other cases, it may make sense to take on “good” debt. For example, if you are buying rental property, a mortgage could be used as “leverage” for an income producing asset that can also increase the equity you have.
Plus, the interest you pay on a mortgage for your primary residence is generally tax deductible. If you take out a home loan and use those funds for home improvements, you may be able to deduct the interest you pay for the improvements.
With interest rates currently at historically low levels, it might be a good idea for you to refinance your home and lower your monthly payment and / or withdraw money for other needs, such as paying off balances. high interest credit cards, adding to your retirement investments. , by increasing the amount of your emergency fund, or even by paying off part of the principal balance you owe on the mortgage. In this case, however, make sure that you plan to stay home for at least long enough to break even refinancing the loan.
Before making a decision
Before you pay off your mortgage, there are some administrative things to consider, such as answering the following questions:
• Do you have an emergency fund in place? If so, does it contain enough for at least six months of living expenses?
• Do you have other high interest debt balances (like credit cards) that are still in place (costing you about 20% in interest charges)?
• Have you paid your annual IRA contribution (individual retirement account) for the current year? If you are 49 or under, you can contribute up to $ 6,000 this year and up to $ 7,000 if you are 50 or older.
• Are you contributing the maximum amount to your employer pension plan, such as a 401 (k)? For 2021, you can contribute up to $ 19,500 if you’re under 50 and up to $ 26,000 if you’re 50 or older.
• Would it make more sense to refinance your mortgage (and possibly withdraw money), given that interest rates are currently at historically low levels?
• Will the performance of other investments beat the interest charges on your mortgage?
• Will you still have enough cash on hand or will paying off your mortgage drain your available savings?
• Is there a prepayment penalty for prepaying your mortgage balance?
Put your plan in place
Before you commit to paying off your mortgage – or adding to your investment portfolio – you may want to discuss all of your options with a financial advisor who can review your situation and overall goals. This way, you will be better able to compare the short and long term advantages (or disadvantages) of either scenario.
Additionally, working with a counselor who knows issues affecting the LGBTQ community can provide an added benefit, as various laws regarding same-sex couples may also be factored into your overall plan.
This article appears in the April 2021 issue of OutSmart magazine.