Are stocks a better bet than my mortgage?

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Dear Retirement Adviser,
I’m 58 years old and I have an 8-year-old adjustable-rate mortgage with an interest-only option. The interest rate for my loan is 3.45 percent. I am making additional principal payments each month to pay off the mortgage in 12 years. We plan to retire and downsize before that, in about seven years. Our house is likely valued between $175,000 and $200,000.

Would it make sense to stop making the principal payments and invest more into a 401(k), an individual retirement account, or something else to buy a new, smaller house?

Right now, we’re focusing our retirement housing funds in one basket: the equity in the current house. I expect in seven years the current home may be worth $250,000 or more, but I could also accumulate a new home fund using stock funds to create funds to buy a new home. What would you advise?

— Russ Retirement

Dear Russ,
The typical interest-only adjustable-rate mortgage, also known as an “I-O ARM,” becomes an amortized loan at year 10. If that’s true of your loan, you have just two years before monthly principal payments become mandatory. You will see the monthly mortgage payment increase by quite a bit because the loan will be amortized over 20 years instead of 30. Your budget should be able to cover it, since you’re making additional principal payments now.

If you have enough equity in your home to avoid the cost of private mortgage insurance, or PMI, I’d suggest that you look into refinancing. Bankrate’s national average for a 15-year fixed-rate mortgage is 2.96 percent and 2.68 percent for a five-year ARM.

I don’t have a quote for you on a seven-year ARM, but that could be the best choice since you plan to sell the home in seven years.

You’ve already made an investment in your home. Now, you are deciding how much leverage you want in that investment. Since you’re planning to sell your current home when you downsize, you’ll have that equity to put toward the purchase of your retirement home. I don’t think you need to take on the added risk of investing in the stock market to buy your dream retirement bungalow. It is a reasonable goal to try to have the house paid off before retirement. That means paying down principal.

One exception I’ll make to that is, if your employer matches all or part of your contributions to its 401(k) plan, then you’ll at least want to contribute up to the limit of the company match.

When the stock market does well, homeowners like to think about how they might be better off if they used their home’s equity to invest in the stock market. That’s one reason to have an interest-only mortgage. While that can be true, a couple just seven years away from retirement shouldn’t count on the stock market being a better investment than their home.

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