Decision to pay off home mortgage early isn't always so simple
Decision to pay off home mortgage early isn't always so simple

With all the recent focus on lending practices, foreclosures and economic pressures in general, I've been getting a lot of questions from readers concerning the pros and cons of paying down a mortgage. Understandably, many people are concerned that carrying a mortgage might be a detriment to their financial future. And those struggling to meet their monthly mortgage payments are wondering if there's any light at the end of the tunnel.

First of all, I want to stress that having a mortgage isn't necessarily a bad thing. Because of tax deductibility and relatively low interest rates, a mortgage can be a valuable part of your financial planFor those folks close to retirement, this might be especially interesting, since lessening debt in this phase of life can be both economically and psychologically freeing.

So back to the question: Should you try to pay down a mortgage early? Seems simple enough, but the answer is a bit more complicated. It depends a lot on your personal situation.

The extra dollars you put toward decreasing your mortgage may actually be better spent elsewhere. Before focusing on your mortgage, make sure you've first covered the following bases:

•Have you saved enough for retirement and taken advantage of any available employer match within your company retirement plan? To me, this should be number one on your list. At the very least, contribute enough to take advantage of any available employer matching contribution. Failing to do so is leaving free money on the table.

•Have you paid off your "expensive” debt? High-interest, non-deductible debt is the type of debt to get rid of first. For most people, that means credit card debt and possibly an auto loan. If you have multiple credit cards, start by eliminating the amount on the card with the highest rate. Not paying that extra 13 percent to 18 percent a year could ultimately give you more cash to put toward your mortgage.

•Do you have an adequate emergency fund? Everyone should have at least three months of living expenses stashed in a safe, liquid investment vehicle for that proverbial rainy day. If something happens — an unexpected illness or unemployment — your emergency fund can help you avoid more debt. And the fund might keep you out of foreclosure.

•Have you maxed out your retirement savings contribution? Assuming you've taken advantage of any employer match and have an adequateemergency fund, your next step should be to fund your retirement accounts to the maximum the law allows. If you're over 50, take advantage of the "catch-up provision” and add extra money to your 401(k) or IRA.

•Have you saved for your child's education? Setting aside money for a child's education — through tax-advantaged vehicles like 529 plans — could be higher on the priority list than decreasing your mortgage amount.

•Do you have a home equity line? If you do, it's probably at a higher rate than your underlying mortgage; it only makes sense to pay down your equity line first.

Tax-deductible interest is often cited as one of the biggest pluses for carrying a mortgage. And for many people that tax break is significant, especially if you have a large mortgage or are in a high tax bracket.

Currently you can deduct the interest expense on up to $1 million of home-secured debt — used to purchase or make capital improvements on your qualified principal and/or second residence. You may also subtract the interest expense on up to $100,000 of home equity debt secured by your home. But once you've paid off the original mortgage, you'll be limited to the $100,000 home equity debt ceiling, unless you make capital improvements or buy another home.

You need to carefully consider how your mortgage interest deduction impacts your overall tax situation. Consult your tax adviser if you have questions.

If you have all your other financial ducks in a row and you've decided that the tax advantage doesn't warrant carrying the mortgage debt.

•What's your "after-tax opportunity cost?” Figure out what your mortgage loan "really” costs once you've factored in the tax deduction. Compare that with your potential investment return. For example, if you're in a 40 percent tax bracket, your 6 percent mortgage loan effectively costs you 3.6 percent.

Could you make better than a 3.6 percent after-tax return by investing in the financial markets rather than paying down your mortgage? The answer is probably "yes.” •Does your mortgage have a prepayment penalty? Typically, traditional mortgages don't contain prepayment penalties.

For many people, particularly those nearing or in retirement, the comfort derived from being debt-free outweighs all other considerations. And no one can argue with that. If paying off your mortgage is one of your goals, you can do it in small increments (even one extra payment a year can take years off your mortgage). Or you may pay a lump sum at some point prior to your final due date.

Whatever your decision — you might want to talk through your options with a financial planner — make sure the terms of your current mortgage are the best you can receive.

Having the right mortgage at the right time can be the ultimate answer. After all, a mortgage often represents more than an investment; it represents home, family and hopes for the future.

Paying too much for your mortgage can get in the way of your other goals and dreams; therefore, decreasing the amount steadily may be the best way. And for a lucky few, paying it off completely can be a dream come true.

Carrie Schwab Pomerantz is Chief Strategist, Consumer Education, Charles Schwab & Co., Inc., Member SIPC. You can e-mail Carrie at ask carrie@schwab.com.

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