Paying down mortgage can help retirement

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Dear Dr. Don,
I currently have 20 years left on my home loan at 5 percent. My payments are $923.94. The balance on the loan is $140,000. I want to retire in 10 years, so I thought I’d hurry up and pay off my mortgage to avoid that expense in retirement.

If I make double payments for the next 10 years, how much will I save on interest? How long will it take to pay off loan? How much will I save on interest and payments? Or should I simply pay it off from my savings, which is only earning 3 percent annually? It is money I got from an insurance policy.

What is the present value and future value of paying off my home loan early?
— Martha Mortgage

Dear Martha,
I think it’s a great goal to have the mortgage on your primary residence paid off by the time you retire. Bankrate has a host of mortgage calculators that can show you how different payment options will impact your payoff date and interest expense. I like the mortgage loan calculator for this work.

Tapping your savings to pay off the mortgage instead of making additional principal payments can work, too. My rule of thumb is that this approach makes sense if you expect the effective rate (after tax) on your mortgage to be greater than the after-tax return on your investments. Don’t dip into your emergency fund to pay off the mortgage.

If you’ve got money earning 3 percent annually in savings, the after-tax rate would be about 2.46 percent, assuming a combined federal and state tax rate of 18 percent. You can calculate the effective rate on your mortgage using Bankrate’s mortgage tax deduction calculator.

I did so and used the same 18 percent combined tax rate. It gave me an effective rate of 4.12 percent. This assumes you can fully utilize the mortgage interest deduction on your taxes. If you can’t, the effective rate on the mortgage is somewhere between 4.12 percent and 5 percent, given the tax rates used in my example.

I’m not sure what you’re trying to get at in asking for the present value and future value of paying off your home early. There are too many variables to model something useful for you in decision making.

If you can save between 4.12 percent and 5 percent by paying off your mortgage, it makes sense to do so versus earning 2.46 percent after-tax in your savings account.

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