Overpaying your mortgage is a worthy goal—but maxing out your 403(b) is even worthier.
Short of coming into an inheritance or winning the lottery, itʼs a rare individual who has enough spare cash lying around to pay for a property outright. Which is why for most of us pursuing the
American dream of homeownership, mortgages are a necessary evil. I always think of mortgages as “good” debt, as opposed to credit cards or personal loans. Of all the debts you could be saddled with, a mortgage can be the least burdensome in terms of interest rate. Since itʼs a type of installment loan, a mortgage can actually be good for your credit score. In addition, federal law allows borrowers to itemize any amount paid in mortgage interest.
Even though part of your mortgage payment may be tax deductible, letʼs do some rough math to determine how much you really are paying. If your mortgage rate is 3% and you are in the 25% income tax bracket, your after-tax rate is actually 2.25%. So, if you have non-emergency money accumulating in a cash account, you want to compare how much the bank is paying you in interest for that account versus how much you are paying the bank for that loan. Bear in mind that most checking accounts currently offer an interest rate well below 1%.
Thatʼs why paying off your mortgage sooner rather than later can only work in your favor.
If, like me, you run a tight ship where household budgeting is concerned, you may have the cash flow to make that happen.
If you simply canʼt find room in your monthly budget, you may want to consider using part of your work bonus, or other unbudgeted-for cash injection, as a lump-sum prepayment.
Thinking of overpaying? Things to keep in mind…
1. Beware: Some mortgages have a prepayment penalty. So always make sure to check with your mortgage lender if itʼs okay to overpay (or “prepay”).
2. Once youʼre sure that your mortgage doesnʼt impose a penalty for paying in advance, look at your cash flow to see how much you can comfortably prepay per month, but only after youʼve taken care of credit cards and other “bad” debts, maximized all eligible contributions to tax-advantaged accounts, built an emergency fund and covered all your insurance needs.
3. Also keep in mind that overpaying your mortgage may interfere with other goals. For example, even though I can be somewhat obsessive-compulsive when it comes to paying off debts—even good ones—I try to make sure I have enough left over for other nonessentials, like family vacations. So when youʼre considering how much you might want to overpay on your mortgage, be certain to take into account additional expenditures that might be coming your way.
“My investments arenʼt doing anything in this low interest rate environment…should I prioritize prepaying over saving?”
This intuitively seems right to a lot of people, but the fact is, itʼs when your 403(b) is dropping in value that you should be contributing the most! Think about it: When the underlying stocks are not doing well, youʼre buying low, which means that your contribution of $200 per month is buying you more shares during a down market. So while holding off on your 403(b) contributions can feel like the right thing to do, it rationally makes little sense. Look at the historic performance and youʼll see that the stock market bounces back eventually, even after big depressions. Few of us expect to withdraw funds for several years (unless youʼre nearing retirement), so there will be time for the market to bounce back.
So go ahead and max out those 403(b) contributions—and if you find extra money in your budget, you can also reap the benefits of overpaying on that mortgage.
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