Paying off your mortgage is not anymore the most confusing decision. Some people might say it was, when the interest rates were floating between 6% to 9%, or even 11% to 13% couple of years ago. But, in today’s low rates, you don’t have that much urgency to pay off your mortgage right now.
Still, it feels good when you pay down that ugly mortgage burden as quickly as possible. But, before you issue a payment check to your lender, you must look at the financial priorities you need to maintain for your family and yourself. According to your priorities, here are the corners where you should fill the boxes first before you start making extra mortgage payments.
1. Take off the credit card debts
Pay off all your credit cards, which has high-interest rates. If you really want to pay off a secured debt like mortgage, then pay off the high-interest unsecured debts first. If you check carefully, you’ll see the huge discrepancy between credit cards (interest rates from 13% to 23%) and mortgage (interest rate 4%).
2. Save for emergency fund
You should create an emergency fund for 8 to 12 months of living expenses. In today's competitive market, you can’t depend on your current job. If you suddenly need to find another job for yourself, you need to be prepared for bearing expenses for few weeks to months.
3. Arrange for retirement
Do you contribute up to the maximum yearly contributions towards your retirement accounts? Consult your accountant to know what will be the maximum allowable for you. Try to reach that amount and save it in 401(k), IRA, or an equivalent investment.
4. Save for your kids education
Save for your kids and their college funds. Calculate the amount depending on the number of your kids, their age, and what type of college enrollment expectation they have. You need to be making enough contributions to those 529 plans or other college savings accounts.
5. Stay healthy
Another important investment you need to make each year is to contribute towards long-term health care insurance. It’s easy to start for healthcare when the cost of insurance is low, at your 30s or 40s. If you ignore it till your 50s, then the cost of insurance premium will take a bigger cut from your monthly budget.
Once you have saved and paid out all the above, you are prepared to cut the mortgage from its root with the remaining funds you have left.
But, how fast and how much should you pay down? You need to calculate it by counting backwards. If you want to retire and need to be mortgage-free by the age of 65, then calculate how much you will need to contribute extra monthly or yearly to pay it off by that date.
One important factor that many people don’t understand is that when they are shifting the loan term from 30 to 20 of their mortgage payments, they are actually paying very little interest compared with what they paid in the early years. In a 20 year mortgage, you are paying the major capital part rather than interest through your monthly installments. But the opposite goes for a 30-year mortgage, the interest rate is low, but the term is long.