Dear Dr. Don,
Since my child finished college a couple of years ago, I’ve been contributing 10 percent of my salary to my 401(k) plan. The balance is now $194,000. My employer matches 50 cents to every dollar up to 2 percent of my salary, which is $80,000 a year.
I’m 50 years old and a single mom. I make additional principal payments of $100 every month to shorten my mortgage term, having made 38 out of 180 payments on the home loan. The mortgage interest rate is 3.875 percent.
Beginning next year, I’m thinking of reducing my 401(k) contribution to 6 percent while adding $500 in extra monthly mortgage payments. In 2016, I’d resume 10 percent
I’d continue to alternate between the two approaches. Do you think this is a good idea? If I change careers, make less money or lose my job, I’d be free of mortgage expenses down the road and could hold on to the house.
— May B. Ready
I’d advise that, at minimum, you should contribute up to the limit of your employer’s 401(k) match. Since that’s less than the 6 percent you’re thinking of contributing next year, either of your two alternative approaches would work.
It’s terrific that you want to be free of the mortgage expense before you retire. I like that you are thinking about a variety of scenarios so you can remain in the house if financial circumstances change.
If your credit is good, you should consider refinancing your 15-year mortgage. Let’s assume that the rate for a 15-year mortgage is 3.21 percent, which was the case as I wrote this. If you make additional principal payments on the refinanced loan consistent with your current mortgage expense, you’ll save money on interest and reduce the effective mortgage loan term by six months. While you also must consider closing costs, you should still be way ahead with the refinancing method.
|Interest rate:||3.875%||3.21%||0.665 percent|
|Loan term (months):||142||136||6|
|Additional principal payment:||$0||$346.04||$346.04|
|Total monthly payment:||$1,705.45||$1,705.45|
|Total interest expense:||$48,173.54||$37,626.79||$10,546.75|
If you leave your current employer at age 55 or older, you can take money out of your company’s retirement accounts without paying the 10 percent tax.
I’d prefer that you aggressively fund your retirement, rather than switch between paying down the mortgage and favoring your retirement account.
My rule of thumb is that you should prepay your mortgage when you expect to earn less on your investments (after taxes) than the after-tax effective rate on your mortgage.
If you get forced out or change careers after age 55, your retirement plan can provide a financial safety net to help you remain in your home. If you don’t leave, you still have the house paid off before retiring and you’ve also built a more robust retirement portfolio.
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