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Money Matters/Early mortgage payoffs aren't a no-brainer

Published 4:39 pm, Thursday, December 6, 2012
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Homeowners dream of the day when they'll make that last mortgage payment. But the decision to speed up your payments to get you to that day sooner isn't a no-brainer.

Consider cash flow

First, it's a good idea to set aside at least six months of living expenses for an unexpected hardship. So if you don't already have that much cash in reserve, consider hitting that mark before you make any extra mortgage payments. Stockpiling cash makes sense, in part because the money is readily accessible. Conversely, after you make mortgage payments, it can be difficult to access the money. You may be able to get a home equity loan or line of credit, but it's harder to do now than it was a few years ago.

You also might be glad you don't have so much wealth tied up in your home if the real estate market continues to struggle. Consider the dilemma of people who bought homes in high-priced markets in 2005 or thereabouts, only to see the value of their residences collapse.

Many of these homeowners are now "upside-down" -- that is, they owe more than their home is worth. If they made extra mortgage payments while times were good, but now walk away from their mortgage, they'll forfeit those extra payments.

Think about ROI

If you have money to spare after setting aside a cash reserve, consider your likely return on investment from extra mortgage payments versus doing something else with that money.

For example, when you pay down a 5 percent mortgage, you might think your return on investment is 5 percent. Don't forget, though, that you can deduct mortgage interest in calculating your taxable income. If, for example, you're in the 35 percent tax bracket, this deduction may save you 35 percent on any mortgage interest payments you make, which means you're effectively paying only 65 percent of 5 percent, or 3.25 percent.

If you think you have a reasonable chance to get a better ROI by doing something else with the extra money, it may make sense to try.

Also consider whether -- in today's competitive interest-rate climate -- you can reduce your mortgage rate by refinancing. You may be able to shorten your mortgage term without increasing your monthly payments, allowing you to pay off your mortgage sooner. If after refinancing you're still considering extra payments, your lower mortgage rate means the chances will be greater that you'll be able to get a better ROI elsewhere.

Look at alternatives

If you carry a credit card balance or other higher-interest debt, your best alternative likely will be to pay it down. After all, reducing a debt costing you 18 percent -- or even 12 percent -- annually provides a significantly greater ROI than making extra payments on a 5 percent mortgage. Plus, unlike mortgage interest, non-business credit-card interest isn't deductible.

Another smart alternative is to max out contributions to your 401(k) or IRA, if you're not doing so already. This not only can reduce your taxable income and position you to reap the benefits of tax-deferred compounding, but also may increase employer matching contributions if available.

If you don't carry other debt and you've already maxed out your retirement plan contributions, consider other investment options. If, for example, you work for a public company and are allowed to purchase shares of that stock at a discount, doing so might provide a better ROI. Just be aware that large holdings in one stock can be risky.

This has been a general discussion meant for informational purposes only and is not intended as advice to anyone. Always discuss your tax and other financial matters with a qualified professional.

Norm Grill is a certified public accountant and managing partner of Grill & Partners LLC, accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Greenwich. He can be reached at n.grill@GRILL1.com.