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Freedom from a mortgage -- a good thing?

No more mortgage payments! Sounds like the ultimate in financial freedom, but it may not be the wisest move for everyone, say Bankrate financial experts Dr. Don and the Dollar Diva. Below, our experts answer a few frequently asked questions regarding the pros and cons of living mortgage free.

When does it make sense to pay off a home mortgage?
Paying off a mortgage is a good idea when you have a lot of money, a stable income stream, and a nice portfolio of securities working for you.

But before you think about paying off your mortgage, make sure you have all of your financial ducks in place. It's a lot easier to give money to your lender when you're flush than it is to get it back when you're needy.

Here's the position you want to be in:

  • You have no other debt.
  • You're making maximum contributions to your tax-deferred retirement plans.
  • You have enough cash in the bank to cover emergencies, such as an extended period of unemployment or major repairs on your home.
  • You have a comfortable portfolio of stocks and bonds working for you.

Remember, you don't have to pay off the whole mortgage at one time. You can gradually reduce the principal by increasing your monthly payments. You should be able to prepay without a penalty, but it's always a good idea to check with your lender just to be sure. The Diva thinks everyone should strive to have their home paid off by retirement. So, if you have all your financial ducks in a row, go for it.

-- answered by the Dollar Diva

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What's the wiser move to make with an inheritance: Invest it or use it to pay off a mortgage?
Let's say the inheritance is $205,000 and so is your mortgage balance. Let's also say that you have a 30-year fixed-rate mortgage at 8 percent, with a payment of $1,500 per month and a full 30 years to run. If you keep the mortgage, you'll pay a total of $540,000 with $335,000 of that being mortgage interest expense. The interest expense will save you about $110,550 in federal income taxes (at the 33 percent marginal tax rate). You can invest the $205,000 and it will be worth about $2,242,000 30 years from now, assuming an 8 percent annual after-tax return, compounded monthly.

If you pay off the balance and invest $1,500 monthly, at the end of 30 years the investment will be worth about $2,250,000; again, assuming an 8 percent annual after-tax return, compounded monthly. But you'll have paid an additional $110,550 in federal income tax over the years due to the loss of the mortgage interest deduction

The portfolio values are close enough that the decision really hangs on the tax benefit. The portfolios are $8,000 apart, and most of that difference is attributable to rounding. I'd choose to invest the lump sum. It gives you financial flexibility that you may need down the road, and allows you to keep the tax deduction. The tax savings could be invested over the years to add to the value of the portfolio. Assuming that you'd receive the same tax benefit each year, invest that at 8 percent after-tax, compounded annually, and the tax savings are worth $417,000 at the end of 30 years.

 Strategy

Ending portfolio value

Tax savings

Ending value
tax savings

Pay off mortgage and invest $1,500 monthly

$2,250,000

($110,500)

0
Keep mortgage and invest lump-sum

$2,242,000

$110,500

$417,000

-- answered by Dr. Don

Is signing up for a biweekly mortgage program a good way to pay off a mortgage quickly?
A biweekly mortgage isn't alchemy. Making 26 mortgage payments a year instead of 12 monthly payments forces you to pay an amount equal to an extra monthly mortgage payment every year. You don't need the bi-saver plan to accomplish this feat since you can do it on your own by making additional principal payments each month equal to 1/12 of a mortgage payment. I recommend that you use the money you'll pay to participate in a biweekly program to make an additional principal payment and pass on the opportunity to participate in the bi-save plan. Either way you'll pay down your mortgage faster and pay less in interest over the life of your loan than if you didn't take these steps. This biweekly mortgage calculator can help you determine the interest savings and how much time you shave off the loan term. But the bi-saver plan won't cut your loan term in half.

-- answered by Dr. Don

 

Bankrate.com's corrections policy
-- Posted: July 3, 2001
 
 
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