Advice on paying off a mortgage early. Q. My husband and I are both in our late 30s. We pay $1,067 a month on our home mortgage (we have ten years left and owe $100,000 at 5.875 percent interest). Our assets include $180,000 at a credit union, $450,000 in our 401(k)s, $117,000 in a cash balance retirement plan, $50,000 in Roth IRAs, and $40,000 in college savings plans for our two children. I've recently stopped working, so I'd like to keep our savings safety net. But we'd also benefit from not having a housing expense. Should we try to refinance or use our savings to pay off our mortgage?
A. You and your husband have obviously made security a top financial priority. It's laudable that you have so much in savings and more than $600,000 set aside for retirement at your age. But yours is the rarest of situations: You might have too much money stashed in your emergency fund.
To have the eight-month cushion I recommend, you'd need to save $180,000 in the credit union account only if your typical monthly expenses totaled $22,500. Based on the size of your mortgage payment, though, I'm guessing you spend far less. This means that if you intend to keep your current home for the rest of your life, you could indeed take $100,000 from your credit union account to pay off the mortgage and still have sufficient savings.
From a purely financial point of view, paying off the loan makes great sense. It's smart to use some of your savings to retire a debt that costs you almost 6 percent. Savings accounts at most banks and credit unions currently pay a maximum interest rate of just 1 percent; the interest is taxable, so let's just say you're pretty much assured to net next to nothing.
I want to stress that the two of you have made terrific financial choices. If the thought of reducing the amount in your savings account to just $80,000 makes you nervous, then don't do it. You've earned the right to do what feels comfortable regardless of what makes the most money sense.
Next: Buying vs. renting when you're in debtAdvice on paying off a mortgage early. Q. I've paid off more than $50,000 in credit card charges with the help of a debt-management program. I'm considering getting a mortgage when I'm debt-free in a few months because it's cheaper to buy a condo where I live than it is to pay rent. Are the monthly savings worth taking on a $150,000 obligation at this stage in my life? I'm 52.
A. You're not free of debt yet, and you're asking if you should take on more? Why not ask me how to build a solid financial base so you never fall into a hole like this again? I don't care how high rent is where you live. Building up your savings should be your priority, not buying a condo.
Besides, you've already made a huge mistake in your calculations: By comparing your monthly rental cost with a projected base mortgage amount, you've dangerously underestimated the real cost of homeownership.
If after reviewing my rules of the road (see The Rental Crunch), you still want to buy, then take out a 15-year, fixed-rate mortgage on a condo you can afford. (Don't even think about trying to save on your initial payments with an adjustable-rate loan.) That way you'll be debt-free before you turn 70. Go with a 30-year mortgage, and you will still be making payments well into your 80s—that's a risky gamble. As a homeowner, you should always plan to have your house paid off before you stop working.
Housing prices are stabilizing, a 30-year fixed mortgage has a phenomenal 3.75 percent interest rate, and rents are up about 5 percent nationwide. Before you head out to an open house, though, make sure you meet the guidelines below to see if you're really ready to buy.
You don't plan to move for at least five years. Any sooner, and you could end up losing money if your home hasn't appreciated the 8 percent or more it will take to cover your selling and relocation costs.
You factored in property taxes, insurance and maintenance—not just your mortgage costs—when deciding on your budget. Don't assume your current rent is a good reflection of how much house you can afford. Add 30 percent to your base mortgage amount to cover additional expenses you don't pay for as a renter.
You can make a down payment of at least 10, but ideally 20, percent. Remember, if you put down less than 20 percent, the bank requires mortgage insurance, which adds to your cost.
You can withstand a TSA-level financial pat down. Lenders will request a dizzying array of financial documentation—your bank and investment account statements, pay stubs, tax returns—and may keep circling back and asking for more paperwork until the day you close. And in the new world of chastened mortgage lenders, you need a great—not good—FICO score just to get a deal done. According to mortgage software firm Ellie Mae, applicants denied a conventional (non-FHA-backed) mortgage in 2012 had an average score of 733.