Dear Dr. Don,
I am 31 and want to pay off my house as soon as I can because I don't like owing people money. I have $195,000 left on my mortgage at 6⅛ percent. Would it be wise to pay off my house? (My goal is to do it within six years.) Or, should I start saving for retirement?
I am not currently saving for retirement because I'm putting my savings toward paying off the house. I feel if I can pay off my house than I would have plenty of time to save for retirement at 37 years of age. I am currently putting $2,000 extra toward principal each month.
-- Nick Noloan
If your company matches all or part of your contributions to a retirement plan, you should -- at a minimum -- contribute up to the limit of the company match. That's free money that you don't want to leave on the table for the next six years.
My rule of thumb is to prepay your mortgage if the after-tax return on your investments is expected to be less than the effective (after-tax) interest rate on your mortgage.
You can estimate the effective rate on your mortgage using Bankrate's "Mortgage tax deduction calculator" can help you find the rate after-tax (effective rate) on your mortgage. The more conservative you are as an investor, the easier it is to justify prepaying your mortgage.
If you're making additional principal payments of $2,000 a month on your mortgage, you've got enough income to work toward both goals.
The earlier you start investing for retirement, the longer that money has to grow. Waiting six years to start saving for retirement makes it that much harder to meet your financial savings goals for retirement.
The "Should You Prepay?" calculator on SmartMoney.com is one of the easiest calculators to use in making a mortgage prepayment decision.