Is it wise to pay down your mortgage if you plan to stay in your home for a long time? – FiLife.com

  J. David Lewis Answer

It is hard to answer this important question in a “one size fits all” fashion. It will be more useful to say a few words about mortgage debt and total debt. Think of home financing as a mortgage that is XX% of its value. Or, your car financed with a loan that is some percentage of its value. Then there is credit card debt that may have paid for events that are only memories. Add it all up and you have “total debt.” Among these debt choices, the home mortgage is probably least expensive, when the tax deductable interest feature is taken into account. If you are going to pay “extra” on your total debt, pay the most expensive first.

Another way to think about interest expense is to consider the certainty of your future interest rates. Home mortgages current offer some of the lowest long-term fixed rates our economy has seen in many years. Not only are these rates low, relative to history, they will not go up until the loan is paid in full through the normal monthly payments, unless you decide to sell the home and buy another at the interest rates then. The next car loan, in two to five years, can have a higher interest rate than the last one. Credit card interest rate can change very often. Given choices, keep the balances low on the balances where there is more risk the rates will go up in the future.

Finally, think about your total debt, but don’t think about it in absolute numbers of dollars. Think of it as a percentage of total assets. Add up

Finally, think about your total debt, but don’t think about it in absolute numbers of dollars. Think of it as a percentage of total assets. Add up all bank accounts, investment accounts, other investments, home, cars, boats and everything else that estimates your total assets. What percentage of total assets is represented by your total debt? Young people, who own homes in their 20s and 30s, can expect this ratio to be high – like 40% to 45%. That is not too frightening, if you earn enough to make the payments AND at least contribute enough to retirement plans to get all employer matching contributions. Both paying debts and building investments reduce the debts’ percentage of total assets. Assets are going up while debts are going down.

You want to do both, such that the ratio falls into the 30% range by age 40 and 20% by age 50. Ideally, I like to see this ratio reach 10% or less by age 60. That means, you can sell a relatively small portion of your total assets to pay off all the debt at any time you choose. Maybe this can help think about managing debts in a framework that will work for many people.

Recommended Posts