Refinance
Should you pay extra on your mortgage?
Paying off your mortgage more quickly is a great idea.
Chipping in a little extra each month can shave years off your loan and save tens of thousands of dollars in interest charges.
Our accelerated mortgage payoff calculator can figure out how quickly you can pay off your mortgage and how much you'll save.
You don't have to pay lots of fees to pay off your mortgage more quickly, either. Our 3 free ways to pay extra on your mortgage will show you how.
But that's not always the wisest use of your money.
Here are three things you must do before paying extra on your mortgage.
Must-Do 1: Build up your emergency savings.
Everyone needs at least six to nine months of living expenses in a readily available savings account or CDs that are not tied up in a 401(k) or individual retirement account.
Without that financial cushion, you could lose your home, including the extra money you worked so hard to put toward the balance, if you get laid off or become ill and can't work.
Before the financial crisis, you might have planned to live off your credit cards or home equity lines of credit. But with banks slashing credit limits and canceling accounts with little warning, that's no longer a realistic expectation.
Must-Do 2: Pay off high-cost credit card debt.
You'll save a lot more by paying down credit card balances that often cost 18% or more than by paying extra on a mortgage that carries a 6% interest rate.
The benefits are immediate. As you pay down credit card debt, the minimum monthly payments drop as well. And when the balance is gone, you don't have to write a check at all.
No matter how much extra you pay on your mortgage, the minimum monthly payment never changes. The length of the loan just gets shorter, so that instead of taking 30 years to pay off, it might only take 26 years.
Plus, you can usually deduct what you spend on mortgage interest from your taxable income. Credit card interest is not tax deductible.
Must-Do 3: Contribute to your retirement plan.
If your employer matches all or part of your contributions to a 401(k) plan, make sure you're putting in enough to collect the full benefit.
Not taking advantage of matching retirement fund contributions is saying no thanks to free money.
If, for example, your employer matches 50% of your contribution up to 6% of your income, that's like getting a 3% pay raise and earning a 50% return on your investment.
Where else can you find that kind of a deal?
It makes sense to contribute even more to your retirement plan if you can get a higher rate of return after taxes than you can by paying extra on your mortgage.
Economists Gene Amromin of the Federal Reserve Bank of Chicago, Jennifer Huang of the University of Texas at Austin and Clemens Sialm of the University of Michigan recommend a simple way to decide if that is true:
Multiply your mortgage rate by 1 minus your tax rate. If the result is higher than what you typically earn with a conservative investment in your retirement plan, pay down your mortgage. Otherwise, contribute more to the retirement plan.
Example: Say your mortgage interest rate is 6% and your tax rate is 25%: 1 minus 0.25 equals 0.75. Multiply 0.75 times 6% and the result is 4.5%. That's your real mortgage rate when you consider the mortgage tax deduction.
If government bonds in your retirement account pay 5%, you're better off investing in retirement than paying off your mortgage.
If bonds are paying 3.5%, however, it's better to pay off your mortgage after you have made the maximum retirement contribution your employer will match.
With the Federal Reserve pushing interest rates artificially low, most investors will find it makes more sense to pay down their mortgage than max out their retirement plans right now.
But that could change when interest rates start going up.
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