of the keys to financial independence is affordable housing. In many
cases, you can gain valuable financial breathing room by paying off
or refinancing your mortgage. Here are some points to consider before
deciding to do either one.
Off the Mortgage
If you're younger than 40, funding your
retirement probably comes first. Put your investment dollars into
401(k) plans and IRAs before you start paying off your house.
The mortgage interest tax deduction is
an emotional rather than a financial reason to keep a house payment.
The deduction is only a percentage of the total you pay out, so its
relatively small benefit is far outweighed by the larger benefit of
not having a payment.
For homeowners over 50, focus on paying
off the mortgage. In some cases, it might even make sense to do so by
taking money out of your investment portfolio. If, for example, part
of your portfolio is in a money market account earning around 1%, and
you're paying 5% on your mortgage, it's a no-brainer to pay off the
mortgage. Then you can make monthly "mortgage" payment back
into your investments.
It's usually not a good idea to pay off
the mortgage by taking money out of a 401k or IRA, unless you are
over age 59.5, are in a very low tax bracket, and have a low mortgage
balance. Otherwise, you may be better off to keep the mortgage rather
than pay the taxes and penalties on the withdrawal.
I am biased toward having a paid-for
home at retirement, because it allows you to live more comfortably on
a smaller income. However, this is an individual decision that really
comes down to how you will sleep at night. For many retirees, the
increased cash flow and security of living in a paid-off house are
worthwhile. Others may prefer to make house payments and leave their
investment funds untouched.
Refinancing your house at a lower
interest rate won't automatically save money. There's always a cost
to refinancing. Compare the total remaining interest you will pay on
the current loan with the total interest you will pay on the new
loan, plus the closing costs. Comparison shop among at least three
lenders to get the best interest rates and lowest refinancing costs.
If you have a short-term mortgage, so
much of your payment is already going to principal that refinancing
probably doesn't make sense. The same is true if you have less than
about five years left to pay. If you plan to sell the house soon, you
need to compare the interest savings and associated refinancing costs
for the years until you expect to sell rather than for the remaining
life of the loan.
Know your reason for refinancing. Is it
to save money on interest or to lower your payments? If refinancing
extends the loan period, you could end up paying more total interest
even with a lower rate. That might be a good choice if you're having
trouble making payments and the longer term could help you stay in
If you can refinance for a longer term
at little or no increase in the total cost, go for the longer term.
The lower payment gives you more flexibility in case of a job loss or
other crisis, and you can always choose to prepay to save money.
Make Your Own Best Choice
There is no hard and fast rule about
when it's best to pay off or refinance your mortgage. The bottom line
is to make the choice that will help you live more comfortably, both
emotionally and financially, in your own home.
Rick Kahler, Certified Financial Planner(r), MS, ChFC, CCIM,
founded Kahler Financial Group, and became South Dakota’s first fee-only
financial planner in 1983. In 2009, Wealth Manager named Kahler Financial
Group as the largest financial planning firm in a seven-state area. A
pioneer in the evolution of integrating financial psychology with
traditional financial planning profession, Rick is co-founder and
co-facilitator of the five-day intensive Healing Money Issues Workshop
offered by Onsite Workshops of Nashville, Tennessee. He is one of only a
handful of planners nationwide who partner with professional coaches and
financial therapists to deliver financial coaching and therapy to his