In an ideal world, being able to save for retirement and pay off your mortgage shouldn’t be mutually exclusive. But for most working middle-income Americans, it’s a matter of choosing one over the other.
Of course, investment firms and lending organizations are more than happy to have a large chunk of your money tied up with them in 401k accounts or IRAs that can’t be touched until you’re nearly 60 years old. They are making profits off your hard-earned savings in the form of management fees either upfront or taken out a little at a time (which are not tax deductible), while your investments are only making modest gains. Sure, you’ll get a deduction from your income taxes for your contribution, but when you reach retirement age and start to withdraw from your accounts, you’ll still have to pay taxes on that money. (Unless you keep it in a Roth IRA, but more on that later.)
If you have a mortgage on your home, a lender is also making money off your debt. Even if your home loan interest rate is only 3 percent, it can still be several thousand dollars a year, and, in a lot of cases, it’s not tax deductible enough to make a big difference. In this case, debt is not your friend. Depending on your interest rate, your $200,000 home could end up costing you $400,000 with a 30-year-loan, which means you could have taken that $200,000 you gave to the mortgage lender and used it to finance your retirement. Today, many Americans don’t pay off their homes before retiring. However, having a mortgage when you’re on a fixed income just doesn’t make sense. When your home is paid for, you can spend your retirement money on living instead of existing.
Financial gurus have made a lot of money encouraging you to save for retirement, and while it’s not a bad idea, being out of debt is just as much, if not more, important. If you own your home free and clear, you’ll still have to pay homeowner’s insurance and taxes, but you’ll no longer have a mortgage payment that includes a large sum of interest going to someone else. All the money you save from making your monthly payment can then go to saving for your future. You also have the comfort of knowing you have a place to live as long as you can keep paying taxes and insurance. Even if you don’t plan on staying in your home forever, or retiring there, you still have equity built-up in the property that you can get back when you sell. You can use that equity to buy a different place, or invest the money from your home sale and use it to rent a place if you no longer wish to own property in your later years. When you are out of debt and own your home, there are so many possibilities.
While this strategy is not popular with most financial “experts,” here’s how it can be done:
If you don’t have a house yet …
Step 1. Stop investing in your retirement accounts, unless your company matches your 401k, and gives you free money. Then invest only up to the amount they match, but no more. Use the extra money to pay off any credit card debt first and then head to Step 2.
Step 2. Start saving for your home one or all of these ways:
- Open a Roth IRA exclusively for saving money toward your home. Invest in no-load funds that are relatively safe, but still make modest earnings. You won’t get an upfront tax deduction, but you can withdraw your principle at any time, and earnings will be tax-free when you withdrawal them at retirement.
- Invest in U.S. Treasury notes or bonds. While they may only pay around 2 or 3 percent, they are one of the safest investments. (It will cost a nominal amount withdraw the money before the note or bond matures.)
- Put funds into a credit union savings account. They don’t pay much interest, but they are safe and your money will be immediately available.
Step 3. Decide how much you can spend on a house. When you have at least a 20 percent down payment, though more is recommended, figure how much you can spend each month, negotiate the price to those standards, and finance for the lowest rate, and as few years as possible-preferably 10 years, 15 at the most. (Never 30 years. Interest rates are higher and it will add greatly to the cost of the property.) If at this point, you don’t feel comfortable making the high payment, then stop, cause you can’t afford the house or you’re not ready to buy. Go back to Step 2 and save more money.
Step 4. As your income grows over the years, add to your monthly principle payment, even if it’s just $50. You’ll be surprised how quickly the amount you owe decreases, when you’re no longer paying so much interest. Once your house is paid off, you will be free from home debt and interest charges, and can now put resources into financing your debt-free future.
Note: You’ll still need to keep a six-to-eight month emergency fund on hand in case you lose your job or income.
If you do have a house
Follow Step 1. Put the unmatched money you were investing in your retirement into paying off your home loan. Consider refinancing if:
- You have 10 years or less left on your loan, it’s probably not worth refinancing.
- If you have 11 to 14 years on your loan, check to see how refinancing may benefit you. The money charged for closing costs may be best used to pay down your mortgage.
- If you have 15 years or more on your loan and have a high interest rate, considering refinancing for 10 years or even less. Shop for a low rate and low closing costs. They can be found.
Follow Step 4. Happy retirement!