To Prepay Your Mortgage Principal or Not?
One of the juggling acts we have with our personal financial life is juggling our mortgage payments, our need to save for our kids college education and our need to save for our retirement. Yet we have only finite resources and income to fund these requirements. Where do our priorities lie?
My friend (let’s call him Mr X) recently confided in me about his mortgage payments. He has a mortgage that he is very comfortable with, but he wants to pay them off as quickly as possible. His accountant obviously has told him that you get tax deductions on your mortgage interests and that he should not be in a hurry in prepay it.
However, Mr X does not like the idea of being in debt. He had seen his parents get in debt troubles and close to financial ruin when he was a kid. It had left a sour taste with him and his attitude regarding debt. He had to take a mortgage when he bought his house because he did not have enough to pay for a house outright! As far as Mr X is concerned, he wants to be debt free (as in free of his mortgage burden) as soon as possible. Yet at the same time, he does realize that any extra cash that he pays to reduce his mortgage principal every month can be used to save for his retirement or his kids college education. His financial advisors have told him that saving for his retirement is very important and he knows he needs to set aside a certain amount every month for that and also his kids college savings. But Mr X told me he would sleep better if he knew his mortgage would be paid off in 10 years rather 20 years.
What should he do, he asked me? Well, my opinion is that if he sleeps better if he has a lesser mortgage burden, then he should make the extra effort to reduce his mortgage. I outlined the following alternatives to him.
1. Take some of your retirement savings and reduce your mortgage immediately. Pros – Mr X sleeps better and his mortgage burden is reduced. Cons – He is taking away his retirement savings from his no IRA or 401k account.
2. Allocate more money each month to repaying mortgage principal – Pros – he will pay off his mortgage faster. Cons – that money can be used for his retirement savings.
3. Cut his expenses even more! and use the extra savings for his mortage principal prepayment every month. Pros – he will pay off his mortage faster and his retirement and college savings plan is “on track” and unchanged. Cons – he has to live an even more frugal lifestyle.
I actually managed to persuade him to go for choice number 3 because that seems to make the most sense to me. I even adviced him to get the Citi® Home Rebate Platinum Select® MasterCard®. This card would allow him to earn 1% rebates which will be automatically used to pay off his mortgage principle every month. (talk about paying off your mortgage faster on autopilot!).
But this conversation I had with him led me to think that sometimes, the most financially sound advice may not be the right choice for a particular individual. In the case of my friend Mr X, he simply hates being in debt. Had he taken choice number 1 and used a portion of his savings to pay off his debt, you cannot really say that was the wrong decision. After all, that is why we call personal finance “personal”. It simply has to suit you, your particular circumstances and your personal values.
What would you have done if you were Mr X. Take part in this poll and share your comments with us.