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.

It's All Greek To Me: Why European Bickering Is Slowing Down Your Investments

Greece is going bankrupt! The Eurozone is crumbling! There are hippos and lions wandering the streets of Tbilisi! Well the thing about the hippos in Tbilisi is true, anyway. Apparently the zoo animals have all escaped during some devastating floods in the capital of the Eastern European nation of Georgia. As to the rest, well, it's all part of Europe's current worry that the Euro, the region's shared currency and 16-year-old experiment, won't survive. In Europe the news that Greece can't make the payments on its loans makes for great headlines. In the U.S., all this European frisson mostly turns up in our investment statements. It's one of the big reasons for that annoying little crawl your investment account has been doing over the past month (last week Golman Sachs declared that our markets were "boring").

To be fair, the niggling daily losses, gains, losses and regains aren't entirely Greece's fault. Our over-caffeinated stock market analysts are flipping coins about when the Federal Reserve is going to raise interest rates,too. But Greece does make a difference. Why? Unless you've been investing big in Greek canned peaches (one of their strongest exports), what you're really worried about is the domino effect within Europe and then, to the rest of us. [Note: I have included a nifty link here in case you would like to import some canned Greek peaches].

The European member created their fancy new currency back in 1999 to turn themselves into one big trading block. That means that they have given and taken out loans to one another, they sell their products—and their peaches—to one another, and their workers all rely on jobs that may well be in the next country over (in 2012 French candidates campaigned in London to reach their voters). This picture of unity works pretty well when times are good, but if country #1 doesn't pay back the loans from country #2, or even if its people can no longer buy those great country #2 imports, then country #2 starts to go down the economic drain. And since everyone is integrated with everyone else, that means country #3 starts to go, along with country #4, country #5, etc... You get the idea.

It turns out that as far away as Europe feels sometimes from the U.S., we do have an awful lot of our own economics tied up in it. And so do Asian countries, African countries and well, Australia. The dominos just keep falling.

So why does Greece matter? Because you don't need lions and floods and hippopotamuses to bring down an economic system. Sometimes knocking over a can of peaches will do it.

Money. The Person Next To You Probably Isn't Doing Any Better

A client walks into my office for a first meeting, puts down an envelope of assorted papers and takes a deep breath. I know exactly what is going to come next. I don't know yet what state her finances are in, of course. But what I do know is that she is already feeling embarrassed—embarrassed because she doesn't have enough money, embarrassed because she should have more, or just embarrassed that she has so much and still doesn't entirely understand what the heck she's doing with it. And don't let the "she" confuse you—all of this embarrassment around personal finances applies equally to men.

One of the most fascinating things about advising people on their finances is that you are often the only person who gets to hear what they are actually thinking about their financial situations. To me, their situations are almost never shocking—I've seen people with a lot more assets than you'd expect and plenty with a lot less than you'd think. What is shocking is how many people think their situations are unusual.

So here are a few bits of random information to make you feel better before the weekend—

Americans owe a total of about $8.17 trillion on their mortgages. Yours is just a drop in the bucket. And if you haven't bought a house, well, this is a good time to look at all those mortgage-bound borrowers and feel a little bit smug about your freedom.

Student loan debt stands at about $1.19 trillion, up about $78 billion from last year, which means that student loans are about as American as apple pie. In fact, more American than apple pie—how many Americans do you know who can make an apple pie?

The National Financial Educators Council tested over 8,000 people from 50 states on very basic financial literacy. The average score for adults 25 to 50 years old was a C-. Our oldest Americans (aged 50+) had the best grade with a resounding 75 out of 100. If you feel badly about the grade for your age group, at least you aren't in the 19 to 24 crowd. They got a cringe-inspiring 67% of their answers right. But then, again, mostly they're just trying to figure out the student loan apps right now.

The whole point of emergency savings is to spend it in emergencies. Also, emergencies—medical, employment, legal, etc...—happen all of the time.

Maybe that last point was not what you were expecting on a financial blog. But I find myself reminding people all too often that making ourselves (or anyone else) feel embarrassed about the ups and downs of life just doesn't make sense. And maybe, just maybe, if we talked about money more as a society, we might see that the person sitting next to us is trying to figure out all of the same stuff.

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Stats are from the New York Federal Reserve's May Report on American consumer finance, available online for anyone looking for some laughs.

One of the best (free!) places to get good information on financial basics is the Practical Money Skills For Life video series—and my blog, of course.