Choices Other Than Prepaying Your Mortgage
Prepaying your mortgage is a great idea, but it might just be the last place you should send any extra money you come across. Consider dedicating funds to areas of your life where you might benefit more rapidly and to a greater extent than the long-term advantages of retiring your mortgage, especially at today’s mortgage rates.
Alternative investments to mortgage prepayment
Since most people have a finite amount of money to invest, it’s worthwhile to evaluate where you stand on other financial imperatives before cutting a check to prepay your mortgage. Think about whether directing funds to one of the seven areas below makes more sense.
Life Insurance.Whether investment-type contracts, annuities, or just good old plain “term life,” life insurance may be crucial to your family's financial health. If you have no life insurance policy, or insufficient life insurance, your untimely demise could put your family or loved ones in emotional and financial distress. Level-payment term insurance is fairly inexpensive, with policies typically available for just a few hundred dollars per year--about the cost of a year's typical mortgage prepayments. Plus, the younger you are, the cheaper insurance costs. A life insurance policy is a low-cost way to protect your family, and may be a better near-term allocation of your resources.
What about a "mortgage" or "credit life" insurance policy --one that pays off your mortgage in the event of your death? Most experts believe that your money would be better spent on a standard life insurance policy (or increasing the benefit on an existing policy) to cover the loan amount. It's likely to be a better value; plus, this additional capital allows your beneficiaries much greater flexibility in their decision making process--the mortgage could be retired from those proceeds, or other bills could be paid.
Disability Insurance.Are you the sole wage-earner in your household? Are you self-employed? If you should become disabled as a result of an accident, could your financial life continue without your salary's contribution for months or even years? The peace of mind a disability insurance policy could bring to you may outweigh any you might achieve from a smaller outstanding mortgage balance. Individual disability policies can be expensive when compared with life insurance, but statistically you are many times more likely to become disabled than you are to die. It's certainly a consideration if you have some money left over at the end of the month.
Retirement Savings.Although some people become disabled or die during their working careers, many more live well into retirement age. Sadly, many need to continue to work beyond age 65 because they failed to take advantage of IRA, 401k, Keogh plans or other retirement savings options. Perhaps the most important component of any investment strategy is the one over which we do have some control: time. The magic of compounding assets over long periods of time is what makes money grow, and contributions to retirement savings plans today can yield many times their "cost." If you aren't fully funding your IRA, Keogh, SEP, 401k or other long-term tax-sheltered retirement plan, it could be wise to do so long before you send additional money to your mortgage lender.
Credit Card Debt.This is among the most expensive and common form of consumer debt; these non-tax-deductible interest rates can be 16% or higher. The average US household held some $6,358 in outstanding credit card debt at the beginning of 2018, according to Experian. With a 3% minimum repayment rate and a 16% interest rate, this would take almost four years to retire -- and cost $1,984 in interest. Accelerating the repayment on the debt with the highest interest rate--even with small balances when compared to a mortgage loan--can return significant savings. Eliminating this debt frees up money which can be allocated to other more productive areas. Because of high interest rates and what can be very long payment schedules at small minimum payments, most analysts recommend tackling this kind of debt first.
Education Plans.The costs of sending a child to school have been rising quickly for many years. If you have hopes of sending your child to college, you could be faced with six-figure bills for a four-year school. While retiring your mortgage debt and building home equity might be a worthy goal, you might need to balance this with establishing and regularly contributing to an Education Savings Account. Many states sponsor Section 529 plans, and the sooner you begin funding those accounts the better position you may be in when large tuition bills are due.
Emergency Fund.Socking away a stockpile of cash to cover emergencies is essential. But how much? Many recommendations focus around three months' worth of living expenses, but in this case, more is better. We suggest as much as six months' worth of living expenses, divided evenly between ready, liquid interest-bearing accounts such as money market or savings and short-term Certificates of Deposit, which are somewhat less accessible.
Home improvement.Homeowners shouldn’t be caught unprepared when inevitable home repairs and maintenance are required and on-going improvements over time should ultimately help to protect your investment. Avoid dipping into your emergency fund by planning ahead to pay for inevitable repairs by setting aside at between one and three percent of your home’s purchase for regular upkeep. Follow a home maintenance checklist to avoid costly repairs at inopportune times.
Enjoying your life.There is much to be said about using resources for vacations or respites that rejuvenate us, and for experiences that enrich our lives. All of these are "investments" in their own right, with "returns" both tangible and intangible. Is it better to pay a bit more toward your mortgage, or to take your children out to a ballgame, or your spouse out for a romantic dinner? Your mortgage will persist for years regardless of how much additional principal you send, but opportunities like these may present themselves for only short periods of time. Of course, if you already go out on the town regularly, this advice isn't for you. Consider spending a few more nights at home, and prepaying your mortgage instead.
Still interested in prepaying your mortgage?
Prepaying your mortgage isn't just a simple question with easy, numerical answers in a ledger or spreadsheet. There are many resource applications that can bring equal or greater rewards.
Now that you've investigated it this deeply, it should be clear that prepaying your mortgage is only a part of a larger, more encompassing financial strategy. If you've prepared for emergencies, disabilities, an untimely death, your retirement, and your child's education; if you've wiped out or reduced your plastic (and other) consumer debts; if you set money aside for household maintenance; if you've kept a little to help enjoy life; and if you still have some money left over, congratulations. You might be a candidate to begin prepaying your mortgage.
Our previous article, Prepay your mortgage or invest instead?, explained tax-related considerations for prepaying your mortgage. After reviewing this article on the alternatives to mortgage prepayment, it may be worthwhile to see if refinancing your mortgage could be the right option for you. See our next article: Refinance instead of prepaying my mortgage?.