Q. I have heard benefits from both sides for either a 15- or 30-year mortgage. The 30 year advocate says to invest the extra money each month into interest bearing funds; the 15 year says to get the mortgage paid off and pay less interest over the long run. Even if I look into a fund that has proven performance over many years, can I be sure that I will make more money than I would pay out in interest over a 30 year loan?
A. A recent study by economists Gene Amromin of the Federal Reserve Bank of Chicago, Jennifer Huang of the
They considered whether it would be better to pay off a mortgage more quickly, or save the extra money in a tax-deferred retirement account, like a 401(k) plan. They found that 53% of us would be better off putting our money into retirement savings rather than our home loans. (Click here to read more about their mortgage vs. savings study.
The three economists also came up with an easy way to make that decision using three key numbers: your mortgage interest rate, federal tax rate and the rate of return you think you'll get from any extra money placed in your 401(k). This needs to be a very conservative number, such as the return on a government bond. Why? Because each dollar used to pay off your mortgage early is a guaranteed return -- you are guaranteed not to have to pay interest on that dollar.
Start by multiplying your mortgage rate by 1 minus your tax rate expressed as a fraction of 1, not as a percent. Compare that return to what you think you can get in the least-risky 401(k) choice. Choose the higher one.
For example, if your mortgage rate is 6% and your tax rate is 25%, the math is 6 times the result of 1 minus 0.25 (or 6 times 0.75). The result is 4.5%. That's your real mortgage rate when you consider the mortgage tax deduction. If your government bonds are paying 5%, you should choose retirement investing over mortgage prepayment.
So do the calculation using the interest rates that apply to you. Look very carefully at the result you get with a typical 30-year rate -- with good credit you could probably qualify for 5.7% or 5.8% loan right now, about one- or two-tenths of a point higher than for a 15-year loan.
If you get a result similar to that of our example, then these economists would argue that you should take the longer-term loan and put the difference in monthly payments into a tax-deferred retirement fund.
By:home-equity.interest.com
1 comments:
You should pay your mortgage off quickly due to the Global Debt Time Bomb. Once this happens it won't matter how much you save in a 401K or any bonds because it will be all wiped out. So I say at least pay off your mortgage so you will have a house that you can live in. Trillions of dollars have been spent keeping the global economy afloat. But now fears about the Great Recession are giving way to worries about something else: The Great Reckoning" when massive debts come due. Then the debt bomb explodes "and the results won't be pretty for investors.
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