Dear Dr. Don,
We presently owe $132,000 on our home mortgage, which carries an interest rate of 5.25 percent. Our home is valued at $375,000. Separately, we are also selling our condo, which will net us $118,000. I’m 59 years old and am still working full time. My wife is retired with no separate income. Should we pay off our home mortgage and invest the funds from the condo sale for a period of time, or are there other options we should consider?
— Mike Mortgage
I think it’s a sound financial goal to have the house paid off before you retire. It frees up a lot of monthly retirement income, which can be applied to other uses.
If you used the $118,000 from the condo sale to pay down your $132,000 loan balance, you’d only need a $14,000 mortgage. Lenders aren’t chomping at the bit to go through the loan underwriting process to write a $14,000 mortgage. And, for you, taking on thousands of dollars in closing costs to get a $14,000 mortgage doesn’t make much sense, either.
My rule of thumb is that paying down your mortgage makes the most sense when the after-tax rate on your mortgage is more than the expected after-tax return on your investments. If you’re looking at a 15-year mortgage at about 3 percent and you can fully utilize the mortgage interest deduction on your taxes, your effective rate is 2.25 percent if you’re in the 25 percent marginal federal income tax bracket.
Bankrate’s Mortgage Tax Deduction Calculator will let you figure out your after-tax rate, again assuming you can fully utilize the mortgage interest deduction when figuring your income taxes.
I’m not sure why you’d only consider investing the condo sale money for the short term. You might want to do that if you had a short-term financial goal to plan to fund with the money. I’d suggest that you take a longer-term view toward investing the money for retirement. Work with a fee-based financial planner to talk about your retirement income needs and how investing the funds can help you to meet those needs.
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