Should I Pay Off My Mortgage Early?

I have heard this question three times in the past month, so I thought it must be on the minds of at least a few more of you. The answer isn't as easy as you might think. There is no denying that it feels great to get any debt paid off early, especially one that could be taking up 20% to 40% of your monthly budget. When a client comes to me wanting to put a little extra money toward getting rid of her mortgage, I am happy to support the effort. But I do ask clients to consider this list of questions. Depending on your answers, you might want to leave the mortgage alone and focus on something else.

1. Do you have a good, fixed-rate mortgage at a low interest rate?

The home buying process is confusing enough that a lot of people walk out of it not sure what sort of mortgage they actually have. If that's you, go check your documents right now. A fixed rate mortgage means that your required monthly payments will stay exactly as they are throughout the life of the loan, and that's great. Any sort of variable rate mortgage, on the other hand, could bring some nasty surprises. Your variable rate mortgage payments will go up if interest rates go up (and they probably will). If that happens just at the moment when you are trying to get costs under control, your mortgage could become a very painful thorn in your side.

By all means, pay off a variable rate mortgage as soon as you can. But if you've got a nice, predictable, fixed-rate mortgage, ask a few more questions...

2. Do you have other debts?

Your mortgage is what we call a "secured loan," meaning that if you don't make your payments, the lender can claim something of value (your home, in this case) to pay off that debt. When lenders write a secured loan, they don't mind charging you a lower interest rate. A car loan is also secured, but let's face it—it's a lot harder to collect value from a used car than a house. And that is why your mortgage is probably the best interest rate you are ever going to get on a loan that isn't from your mother.

This means that your other debts—credit cards and car loans, for instance—are likely to have higher interest rates than whatever you are paying on that mortgage. Mathematically speaking, you want to pay those down first. As you get the loan with the highest interest rate paid off, shift that payment to the next highest and so on. The mortgage will probably be last on this list. [One caveat: student loans are often secured by the federal government and may not follow this pattern, so check your interest rates first!]

3. Do you need to be putting more money away for the long-term?

This one is not always obvious, but think about it—if you are investing money for a child's college tuition or your retirement or anything else that might be more than 10 years out, you are probably planning to get an average return of at least 5% to 8% per year on the money you are investing. If your mortgage is at 3%, then putting the extra $100 a moth toward paying off the mortgage will save you money at a rate of  3%. But if your investment plans go reasonably, you might be giving up 6% or 8% in returns in order to get that 3%.

As you've probably figured by now, the comparison isn't perfect. You are just about guaranteed to save that 3%, whereas investment returns are never, ever guaranteed (no matter how great your investment strategy). But if your targets and strategy are reasonable and you are investing for the long-term, it's a very good bet that your investments will out-perform the savings you got from paying down that mortgage.

4. How much is your tax deduction doing for you?

You probably know that if you live in the home you own you are getting a tax deduction. What fewer people know is that the deduction is actually for the interest you are paying on that mortgage. In fact, in the early years of your mortgage what you are paying is almost entirely interest. To help you visualize that, I found the handy image below from a website called "Financial Tips":

Mortgage-Amortization

In fact, mortgages work through "amortization," which means that the bank builds in the interest payments in a particular way. Specifically, your payments go mostly toward interest (in yellow) throughout the first years of your loan repayment. As you can see from this chart, the balance of your payments does not shift toward the actual principal (in red) until you are more than half-way through paying off the loans. (By the way, this is why you want to make absolutely sure your lender applies any early or extra payments to principal!)

Alright, so you are only getting the homeowner's tax deduction on that yellow stuff. Why do you care? Because tax planning is a strategy game. Being able to take the mortgage deduction during a period when your income is higher (especially if it is just over the line of one of the tax brackets) can mean a significant tax savings. So, in getting rid of your mortgage payments faster, you might be getting rid of a key part of your tax savings strategy.

So, should I pay off my mortgage early?

After you've gone through list, you might find that paying off your mortgage doesn't make sense from a mathematical point of view. But there is still one more question to ask. The fact is that, just as we perform better on exams when we feel confident, we tend to handle all of our financial decisions better when we feel good about the steps we're taking. As I've said to more than one client recently, if paying off that mortgage means that you feel more "on top of" everything else, that might be reason enough.

After Valentine's Day, It's Time to Talk to Your Loved One About Money

Chances are that a least a few of you out there have put off or just outright avoided talking to your partner about money. I know because I see a lot of you come into my office after this has become a problem. But a few recent studies show there are more Americans that you might think who are hoping a little avoidance might keep the tensions down.

In a CreditCards.com survey last January, 6% of respondents admitted to having a secret account or credit card, and far more, about 20%, said that they had spent $500 or more without telling their financial partners. Obviously, most of us won't go so far as to resort to secrecy. Instead we reach an unspoken agreement not to talk about things with our partners. We know it's not a great solution, so why do we do it?

Like the other decisions we make together in a household, financial decisions bring out the differences in our styles, tastes, and priorities. She's happy to spend more on hiking trips; her partner would cut down on the travel to get a better car. Neither position is wrong, anyway. This is simply a matter of preference, and in any healthy relationship, the two will find some sort of compromise. But compromise doesn't work as well when our sense of survival kicks in. And that's precisely what tends to happen when financial discussions turn heated.

Not a few of us are prone to a particularly strong belief that the world is unpredictable, that fate is capricious and that disasters can happen to anyone. When these sort of beliefs simmer in the back of your mind, you are often quick to make the leap from an apparently mundane financial decision to a sense of looming danger and vulnerability. Job losses, medical emergencies, housing emergencies and other far more amorphous dangers float in the back of your mind. And a perfectly innocent partner can trigger those fears by suggesting you take $800 out of the savings account this month to replace the old refrigerator. Those of you with financially anxious partners will recognize this moment and roll your eyes.

But before you get too smug about your ability to keep that $800 fridge in perspective, make sure you aren't one of those partners who spend money in the same spirit of anxiety. People who seem unconcerned about the consequences of their spending may also be living with the sense that catastrophe could strike. For them, hoarding does no good—the best strategy is to secure anything they really want or needs before it all gets taken way.

Not everyone is anticipating a financial crisis, of course, and I haven't got room in this one post to cover all of the other deep-seated emotions, desires, and fears that tangle our financial decisions. But if either of these situations sounds familiar, then those household discussions about everything from grocery bills and vacations to retirement contributions and job changes are going to demand a little extra care and a little extra understanding. As I routinely explain to planning clients, I can give you all of the financial options and the math behind them, but the right choice in the end will be the one you can live with.

So You Want To Buy A House

As I've mentioned before, most of the topics I write about in this blog come from the casual (and sometimes not so casual) questions people ask me every day. One of the big topics lately has been buying a home. You'd think that with all of the pressure on Americans to buy their own homes, we would feel a little more comfortable with the mechanics of it. But most of us end up confused or frustrated at some point in the process. To help prevent that, here are a few things to think about if you are considering a new home.

It's your life

Let's start with the obvious. Some of us buy because we are dreaming of that home. Some of us, though, are just feeling like buying is something we are supposed to do. Yes, a home can be a great investment, but like all investments it can go really badly. Before you buy for investment purposes read this post.

Likewise, buying can make you feel more grown up if your idea of dinner at home is a take out carton and a coffee table you picked up on Craiglist. But homeownership is a pretty expensive way to impersonate a grown up. If you are thinking of spending hundreds of thousands dollars to buy a new place, make sure it's a decision that works for you. Put aside any and all advice from well-meaning family, friends and real estate agents and really weigh whether at this particular point in your life (whenever that is) you actually want to be a homeowner. If the thrills of home decorating don't make up for the frustrations of home maintenance for you, maybe you'd be better off getting a real kitchen table and throwing the extra money in your retirement account. If you do want to be a homeowner...

Do the math

There are a thousand and one mortgage calculators on the web to help you figure out how much you would pay per month and in down payment for the house of your dreams (or a smaller replica of the house of your dreams). I've already posted a basic explanation of how banks calculate your mortgage qualifications.

But it isn't just about what you can afford. Be sure to think about the what you actually want to pay given your other monthly expenses and opportunities. Mortgage payments, like rent payments, fit into the category of "fixed expenses," the things that you can't negotiate if you have a difficult month. It's one thing to cut out the fine dining, put off a trip or cut down on your retirement contributions for a bit; it's a whole other thing to be tied to a high mortgage payment if your income suddenly goes down. Which means you want to do some real soul searching about how much of a mortgage payment you are ready to carry, no matter what happens.

Not So Hidden Costs

We all know there are extra expenses to buying a home, but they look pretty inconsequential next to the home prices themselves. They seem a lot less inconsequential on closing day when you actually start to pay them. From the beginning of your search, keep this list in mind and be ready with cash on hand. And of course, bargain with everyone from banks to sellers for the best deal.

The first of the "extra" costs is the real estate agent's commission  (typically 6% split between the seller and the buyer agents). If you are smart, you'll also pony up for a home inspector whom you trust—you will feel pretty stupid if you scrimp on the few hundred bucks here and find yourself with thousands of dollars in surprise repairs later.

And then there are the famous "closing costs" that come due on the day you get the keys for your new house. In total closing costs generally range from about 2% to 5% of the value of the property, though it's not unheard of to see that percentage go all the way up toward 8% (ouch).

• Bank Fees (the bank giving you the mortgage may charge an origination fee, "discount points", credit report or loan application fees, title search and title insurance fees, a charge for the appraisal, and the initial interest payment)
• Initial property tax payment
• Charge for a survey of the property
• Homeowners Insurance
• Attorney fees (for your attorney)
• Recording fee (to your local government records office when you file your new title)

Your closing costs will be lower if you get tough with your lender from the start (be sure to ask the bank for a Good Faith Estimate—they are required to give it to you by law!). Costs can be shared with the seller if you and your agent negotiate well, and if you've got a little extra room in your mortgage limits, some of these costs can be rolled into your mortgage. This is the place where having a good agent and communicating well with your bank can make a huge difference.

Don't Rush the Process

In all likelihood, you won't end up buying the first home you think you want. Plan to spend at least 3-4 months becoming familiar with the market and just as importantly, focusing in on what you really want. Real estate agents are notorious for bringing clients to homes that only loosely fit the client's "wish list." It's not that your agent wasn't listening to you; it's just that agents have learned from experience that most people only realize what matters to them most by looking at a lot of different properties and changing their minds over time.

Patience can save you money on your home price. And it can save you money after closing. The adrenaline rush of buying a house tends to send new owners into a follow-up frenzy of furniture shopping and DIY projects. This is all made worse by the fact that the $6,000 dining table no longer looks as expensive when compared with the $600,000 condo. By all means, pick up a new couch if you don't have one from your old place. But you'll save money and be happier with your home in the long run if fill in the gaps slowly (or at least wait until $6,000 looks like a big number again).

Ask Around

At this point it might look like I am trying to dissuade anyone from buying a home. I'm not. Buying a home is an exciting process. If this is the next big purchase for you, start by asking people you know about their own experiences. How was their lender? Who was their agent? Their home inspector? Which areas of town did they search? Why did they buy where they did? What would they have done differently, if anything?

The home hunting season starts up in late February. Good luck!

Three Ways To Give Yourself A Break In 2106

'Tis the season to start with all of those self-improving resolutions. Aargh. If you're like me, you are still fighting off the sugar crash from an overdose of green and red frosted products and wondering if your house will ever look the same again after a trail of visiting family. So, I'm scrapping the financial resolutions and focusing on finding the easy path. Here are a few ways to put in less effort around your finances.

Open a spending account

That's right, a spending account. For years (generations?) wise people have been hammering away at us to have a savings account in which we diligently put 10% of our pay every week or two so that we can (somewhat magically) become tycoons in our old age. In actuality, it's pretty good advice. But there are two problems. For one, most of us would be hard pressed to reach tycoon status on our annual pay. And that fabulous .06% interest rate the banks are paying these days can make the savings process can be a little demoralizing in the short-term. Worse yet, it is really, really hard for a lot of us to find an "extra" 10% of our income.

If this sounds familiar, flip the advice on its head. Have your paychecks deposited into your regular account as usual. If you don't already, use online bill pay to have all of you fixed expenses paid automatically (that's your rent/mortgage, monthly subscriptions, health insurance premiums, car or transport payments, memberships and monthly credit card payments). Then put in one more automatic payment—a monthly amount that goes every pay period from your regular account to your new spending account. The spending account will be for anything you want to buy until the next pay check. Some of these are necessary expenses, like groceries. But all of the rest should be for fun stuff—entertainment, nights out, new clothes, gifts for friends, comic books, flowers—whatever makes your day better. And better yet, you can spend every dime of the money in that account. Because the amount you put in for auto-transfer to your spending account left a little extra that wasn't needed for the fixed expenses I mentioned earlier. That little extra just accumulates as savings in your account, growing a little more every week while you aren't looking.

The great thing about this system is that the savings happens without you paying any attention to it. And the spending account is just that—a license to buy whatever the heck you want to get between paychecks—guilt and mathematics-free.

It does happen, though, that we hit times when saving is just not possible. And that brings me to point #2...

The experts are a bunch of jerks

In the enthusiastic crusade to get us all to save for retirement, financial experts, banks, employers and nosy family members have bombarded us with frantic messages about how our failure to be "responsible" with our money will end in cat food and a home under a bridge. Unfortunately, all this advice tends to overlook the fact that in real life, people have good years and bad years. In good years, you really should be putting aside some money, whether it's for retirement, a new house, a new business or just a rainy day. But unless you are very fortunate (and probably had a little parental help with stuff early on), you are going to have some bad years, too. These are the years when medical crises hit, when you or another family finds yourselves between jobs, or maybe just when you are starting out and your paycheck is too crappy to cover much more than ramen noodles and bed in your parents' basement. That doesn't make you financially irresponsible. It just makes you busy with life.

So, ignore the stories about people who socked aways thousands of dollars by eating from trash bins after closing time. If you are that person, you don't need financial advice anyway, but you might look into a good health plan. Recognize that some years are savings years and some are spending years. If you are in one of those years, decrease the amount you are putting aside or eliminate the savings altogether. Measure your financial progress instead in terms of career growth, or personal growth, or just getting back on your feet. After all, those things are all just as important, if not more so, than building your retirement account. Now mark your calendar to check every 6 months to review your situation. When things are looking up financially, it's time to start the savings again, but feel free to start small. And until it is that time, give yourself a break.

Stop expecting to know everything

The whole point of this blog is to help people understand and feel more comfortable with financial issues. As a former professor, I love it when people decide to really dig in and teach themselves more about the financial world and their own investments. But it does take a lot of work and time. Financial questions involve rapidly changing tax regulations, new investment types, new investing laws and constantly renamed and re-jiggered products. That means that unless you are dedicating regular time to reading and research, it's going to be hard to keep up. And that's true even for people who are in related fields like law and banking. If you are interested in the field or just committed to doing it yourself, that's great. But if don't want to spend your evenings learning about index funds, who can blame you?

For those of you who don't want to put in the time, stop feeling guilty and hire an expert. As self-serving as it might sound coming from a financial advisor, the cost of having someone qualified go over your financial situation and goals with you is almost always a tiny fraction of the extra money you can earn, save, or make by following professional advice. This is just as true for those of us in who work for a living as it is for the mega-rich we usually think of as having financial advisors. And let's face it, there's a lot more at stake for us.

Skip the stock brokers and the insurance agents and look for an RIA rep, or at least a CFP, who is focused on planning, as opposed to focused on selling you a particular investment or account. Ask how much a plan costs and what that process involves. A good plan will finish with something in writing you can take away, but should also involve more than one conversation with you to really understand your resources, your debts, your concerns and you goals. All good planners offer a free initial consult—use it, and don't be afraid to keep shopping until you find someone with whom you feel good about working.

And once you've got the pieces of your plan set up for the year, your savings or non-savings strategy in place, and your spending account on auto-pay, treat yourself to one more sugar cookie before you embark on any of those fitness resolutions.

Planning For An Easy Tax Season...before the holiday rush

I don't know about you, but December has taken me by surprise again this year. And even while I get excited about the holiday parties and our traditional Christmas breakfast of strawberries and biscuits, I am also suddenly aware of those end-of-year deadlines. Unless you've been really diligent this fall, here are some simple tasks that will keep you from following up your holiday recovery with panic attacks:

1. If you are a business owner, you need to think about your annual reports for the state, as well as taxes. Here in Massachusetts the reports are often due in the fall. If you missed the deadline, the penalty is small, but you will want to get those in before they get lost in the taxes. Here is your link to the MA state filing forms & instructions.
2. Planning ahead can often save you on taxes. I know you've heard this before, but this is the moment to actually do something about it. Contact your financial planner or accountant now to see whether it makes sense for you to: sell some investments at a loss (to offset other income); sell some at a gain (if, for instance, you think your tax bracket will be higher for 2016 than it is for 2015, or you would rather pay this year); make some charitable donations or gifts to the family; make a big purchase for the business before December 1; set up a trust.
3. Put a little more in your retirement account. Now that you've reached the end of the year, you may find that you can afford to put a little more money into your 401k, IRA or other active retirement plan. The IRS allows many retirement contributions to be made anytime up until you pay your taxes, BUT your plan may well have an earlier deadline. Make your contribution by December 31st to be sure.
4. Set aside some cash if you've had any unexpected income this year. Most people count on the money deducted from their paychecks to cover the taxes that will be due on April 15th. But if you've received money from a side job, from shares in a business, from the sale of some investments, or if you just received a large gift or prize, you probably owe extra taxes. Plan now to keep some cash aside in your account to cover those. And, if this happens regularly, talk to your accountant about paying quarterly estimated taxes to avoid penalties.
5. Get those receipts together. You probably won't get all of the paperwork you need to file your taxes until January or even February. This stuff includes everything from W2 statements to health insurance coverage certificates and bank or investment tax statements. But you can get your tax receipts in order before the holiday and be ready to turn the whole mess over to your accountant as soon as the paperwork comes in. You will be especially glad you did if you are the tax preparer for your household.

Last but not least, make sure you know who is going to prepare the taxes for you and how. If you are one of those brave do-it-yourself tax filers, go ahead and purchase the tax software now. It's ready and waiting for you.

If you hope to turn this problem over to a professional, keep in mind that these folks get harder and harder to find as April approaches. Ask for referrals to a good accountant in your  area (your financial planner always keeps a list) and make contact now.

When the early spring finally hits, you could be enjoying warm sun and daffodils instead of a shoebox of fading receipts and late night caffeine fixes.