Thursday, December 2, 2010

Should You Pay Off Your Mortgage Early?

From Fox Business News.

" investment offers a higher return and has the added bonus of keeping your retirement expenses low: paying down your mortgage.

What’s the “return” on that investment? At the high end, it’s the rate on your mortgage — that’s if you don’t itemize and therefore don’t deduct mortgage interest when you file your tax return. Because the majority of taxpayers don’t itemize, and with the rates on most existing mortgages landing from 4.5% to 7%, the “return” on paying off the mortgage looks pretty good.

What’s the return if you do deduct mortgage interest? Here’s the simple rule of thumb: Turn your tax bracket into a decimal and subtract it from 1, then multiply that number by your mortgage rate* (see bottom). That may sound complicated, but it’s not. For example, someone in the 25% tax bracket with a 6% mortgage rate would earn an after-tax return of 4.5%. Still not bad.

But there’s a bonus benefit of paying off the mortgage before kissing off the boss: You’ll have lower expenses in retirement, so you’ll need less income. The less income you need in retirement, the fewer investments you have to sell and the less money you have to withdraw from tax-deferred accounts. This will keep your tax bill lower. It also could means that less of your Social Security benefit may be subject to taxes. So you’re lowering your retirement expenses in all kinds of ways."


"The first financial priorities for most people should be to pay off credit-card and other consumer debt, build up an emergency fund, and max out tax-advantaged retirement accounts. But once you have those taken care of, paying off the mortgage early is worth considering.

Conservative investors and those close to retirement might even consider paying off the mortgage before contributing to an IRA or 401(k), as long as they’re not passing up an employer match.

If you’re younger, the math is more in favor of keeping the mortgage, since you’ll be investing in long-term investments that have more potential to outperform the rate of your home loan. As you approach and enter retirement, your portfolio should become more conservative — which means that consistently earning 4.5% to 7.0% is not a sure thing, at least not at current interest rates."

28% (tax bracket) in decimal form = .28
1.0 - .28 = .72
.72 X 4.5 (mortgage rate %) = 3.24
(rate of return on pre-paying mortgage--better than you could get at any bank or investment right now other than gold or commodities)

The lower your tax rate, and the higher your mortgage rate, the higher the return.


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