You’ve won the lottery, come into an inheritance, found a few extra dollars in your pants pocket. No matter how you acquired the extra money, if you’re a homeowner, the question looms: Should you use the windfall to pay down your mortgage?
The answer might very likely be “no.”
Recently, AARP’s “Money Saver” column looked at this question, analyzing the situation of a Charlottesville, Virginia couple: Dawn and her partner Stuart. The couple had a combined income of $200,000 and a $2,367 mortgage payment. Dawn wanted to pay an extra $1,400 each month to eliminate the mortgage sooner. Stuart disagreed.
Who was right from a money standpoint?
AARP turned to financial advisor Gary Schatsky for the answer. Running the numbers, Schatsky advised them not to pay down the mortgage.
With the mortgage-interest tax deduction, he noted, their effective interest rate was around 3%. “That means paying off the mortgage gives them a 3% guaranteed return on their money,” noted Schatsky. By contrast, that same money put into a balanced mutual fund “could reasonably be expected to grow 6% over time.”
In other words, the couple would save $140,000 in interest by paying down the mortgage, but give up the chance to grow the same money to $280,000 in a mutual fund.
The moral? Do the math before making extra mortgage payments. While the couple in AARP’s article saw emotional benefits to paying off the mortgage early — “Seeing their mortgage balance drop when they made an extra payment one month felt great,” notes the article—in the end, “the numbers won out.”