Many times, people may receive a windfall or bonus and need to decide the best way to use the money and paying down part of your home loan may be one of the choices.
The alternative would be to take the excess cash and invest it. Which is the better decision, to invest the money or to use it to pay down all or part of your mortgage?
There is no one answer for all people and all times. The current rates of return on the investment you are considering, and how much you are paying on your own mortgage will be the most important considerations. As an example, take a $5,000 bonus that you are deciding upon the best use for.
Mortgage calculators available on the web can tell you how much you have to pay on your home loan, but let us just use an example of a 6.25% mortgage with a balance of $25,000 and five years to go. Using your $5,000 to pay some of the mortgage off would save you $100 per month, or a total savings over the course of the mortgage of $835.
A CD paying 2.5% would yield $657 over five years, so the benefit here is clear, correct? Wrong. If you receive tax savings because of mortgage payments, you would lose any of those savings if you paid down the loan.
And what about the taxes you have to pay on the CD? Does this mean that you should NOT pay down your mortgage with any excess funds you may acquire? No, it means that you cannot only look at the absolute costs and yields of each of the alternatives.
What if you are retired, and don’t have a large income to shelter any more? In this case, the savings from paying off the loan may be more to your advantage.
Another consideration is that CDs may not pay 2.5%, but rather only 1% or 1 %. This may change your calculation considerably. What should you do? This analysis clearly teaches us that each situation is different and you have to do all of the calculations for your own situation.
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This post was written by Kent S. Brown on May 10, 2010
