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Times may be tough economically, but regardless of the strength of the economy or your personal income, before you start making extra payments on your mortgage, here are some things to consider:
Other Debt- If you have outstanding debt, such as poor credit history cards, your best bet is to put the money there. Simply paying 20 percent of the balance of your poor credit history card would reduce the length of time you will be repaying that sum by approximately 25 percent.
Other Loans- The average home loan rate is 5 percent right now, compared to the average auto loan of 7 percent. In addition, you likely owe less for your car than your home so a few large payments could settle that auto debt rather quickly.
Your True Interest Rate- Even if the rate on your home mortgage is a low 5 percent, if you get a deduction on your income taxes for the interest you pay, 5 percent is not your true interest rate. Take for example a person earning $100,000 per year, with approximately 30 percent going to state and federal taxes. If you pay $15,000 in mortgage interest, your taxable income is reduced to $85,000, which means that you pay $4,500 less in taxes than you would have otherwise. The net cost of the mortgage interest is only $10,500.
Better Returns- Using the example above, it also means that your after-tax interest rate on your home loan goes down, for all practical purposes, to 3.25 percent. As such, if you can make a higher return on an alternate investment, it could be a good idea to do so, such as opening a Roth IRA or investing in a CD or T-bond.
Liquidity- There is a cost to not having liquid finances. Imagine that something happens where you need a large sum of money straight away – you need to move to a new home, your car breaks down, you have to take a month off work. If you do not have enough liquid funds to cover those expenses, your only option is to borrow the money from either the bank or a poor credit history card. In either case, you will end up paying more than you borrowed, in some cases significantly.
