Prepay mortgage if you fear risk

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Dear Dr. Don,
I have inherited $168,000. I am 51 with very little in retirement savings. My husband and I own a home with a loan balance of $176,000. We would like to retire by 62 by using deferred comp at work, although we haven’t started this yet, plus pension and Social Security.

Is it better to pay off our mortgage? Or is it better to invest this money? We have about $30,000 in car and credit card debt.
— Sandy Solvent

Dear Sandy,
The decision to use this windfall to pay off your mortgage, pay off your other debts or invest the money elsewhere depends in large part on your attitude toward risk and your willingness to invest in the financial markets.

In general, you want to prepay a mortgage if the effective (after-tax) rate on your mortgage is more than what you can expect to earn after-tax on your investments. Conservative investors are more likely to make the decision to prepay than investors who are comfortable investing in the stock market.

If you’re using the mortgage interest deduction on your taxes, you can use Bankrate’s mortgage tax deduction calculator to determine the effective rate on your mortgage.

Another big question to answer is whether you have the financial discipline to use the money you’ve freed up (by prepaying the mortgage with the inheritance) to invest for future life goals, like retirement.

If your company matches all or part of your contributions to a retirement account, contributing to that plan makes sense. While you can’t contribute from your inheritance, you can use your inheritance to replace the income going into the deferred compensation plan.

If your company matches 50 cents on the dollar, you’re making 50 percent on these contributions before considering investment returns.

Depending on the interest rate on your car loan and credit cards, paying off the car and the credit cards can be a better first step than using all the money to prepay the mortgage. Of course, this assumes there is no prepayment penalty on the car loan.