Dear Dr. Don,
I am single, age 37, and I have a stable job. I own a home that is worth about $310,000 and still owe $201,000 on it, financed at 4.25 percent. After taxes and insurance, I pay $1,210 a month. Since I refinanced in 2010 into a 30-year fixed loan, I still have 28 years of payments left. I make $65,000 a year in base salary and earn an additional $10,000 a year in bonuses, stocks and side jobs.
I have a 401(k) with $40,000 in it and an individual retirement account with $21,000. I save 10 percent between the 401(k) and IRA, plus I get a 401(k) matching contribution from my employer. I also have $150,000 in stocks, most of which I’ve owned for 15 years or more. My checking account balance is currently about $10,000, and I spend about $1,800 a month on bills and luxuries. Should I sell some or all of my stocks to pay down my mortgage?
— Clay Cache
My advice to people who are trying to decide whether to pay off or pay down their mortgage from savings or investments is to consider what they’re earning on their investments after-tax and compare that to what they’re paying after-tax on their mortgage.
You can use Bankrate’s mortgage tax deduction calculator to determine the after-tax rate on your mortgage.
The calculator presupposes that you can take full advantage of the mortgage interest deduction and that the deduction isn’t just replacing the standard deduction on your tax return. If you’re not fully utilizing the mortgage interest deduction, then the effective rate on your mortgage is somewhere between the after-tax rate determined by the calculator and the pretax rate of 4.25 percent.
You don’t say what stocks you’ve invested in for the long haul, but over time, and certainly from the past year, they’re very likely to show a return much higher than the after-tax financing cost on your mortgage. Past returns don’t matter as much as whether you think the stocks will have future returns higher than your mortgage interest expense.
There’s the rub. No one knows for sure what stocks will return in the future. Trading off the uncertain stock returns for certain mortgage interest savings is tempting. I’d argue against it in your case. In your 30s, you have plenty of time to pay off the mortgage prior to retirement. Staying invested in stocks for another 30 years could provide solid returns in your portfolio.
A change in tax policies, both for capital gains taxes and in estate taxes, could factor into your decision whether to sell your stocks. Ideally, the government will give enough notice for people to plan for, versus react to, any changes.
Additional principal payments over time can help you chip away at your mortgage balance. I’d choose that approach — and not liquidating your investment portfolio — if you want to shorten up the effective term of your mortgage.
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