Should I save Extra Money, or Use It To Pay Off My Mortgage Early?

Learn the pros and cons of using excess cash to pay down your mortgage

Home owners looking for the best place to put their extra cash often consider making extra payments on their mortgage to help pay off the loan faster. While it is true that paying off your mortgage with extra principal payments can save you a lot of interest over 30 years, home owners should consider all available other options

The basic question to answer is: Where will you get the best inflation-adjusted, after-tax return on your investment dollars? Inflation will always be a part of our economy, meaning that a dollar today is worth less than a dollar tomorrow. That means that you will pay back your loan tomorrow in cheaper dollars than with today's dollars. Tax considerations are a key factor to take into account since mortgage interest is tax deductible.

The first step for home owners is to look at all other debts besides existing mortgage debt. Most mortgage rates are between 4% and 7%. If you have any credit card debt you should pay that off first because that debt is always at a higher rate and is not tax deductible. Any other high rate debt should also be paid off as well.

Once other debt is paid, the next step is to see exactly how much you will save in interest by paying down your mortgage loan. The primary benefit of paying down your mortgage with extra principal payments is that the savings are guaranteed, while other investment returns can vary.

On the other hand, the savings from less mortgage interest is reduced by your income tax savings. For example, if you will save $40,000 in mortgage interest by making extra payments, you are not really saving that full $40,000 because you would have been able to deduct that $40,000 from your taxable income. Without that deduction, your income tax liability would increase.

Other investment options can include:

* Your Retirement Account with Employer Matching. Retirement contributions are tax deferred, and if your employer matches your contributions then your actual return on your money saved can be double the first year. For example, if you save $1,000 and your employer matches with another $1,000, then your return on that investment is 100% before any return from savings or investment interest or dividends.

* Savings or money market account. Right now savings rates are between zero and 3%. Even taking tax savings into account, paying down your mortgage is right now a better use of cash than putting money into these savings instruments.

* Stocks and Mutual Funds. We have all seen what the stock market has done over the past three years. The good news is that historically stocks have averaged a return of nearly 10% over the decades. The bad news is that the past few years have been extremely volatile and many stocks have not recovered from the disaster of the past few years.

What Stage of Life Are You At? If you are just starting out, do not forget to build an emergency cash reserve fund before doing anything else - even paying down credit card debt. Especially for home owners, unexpected emergencies pop up. This fund can also help cushion against periods of unemployment.

If you are nearing retirement and expect your income to decrease soon, then paying down your mortgage may not be the best option. You may need that extra cash for living expenses and the tax savings is less if your income is less.

For those who prefer more certainty, paying down mortgage debt can provide the best option for guaranteeing future savings on interest payments. Until the financial markets return to a more normal rate of return, mortgage principal payments may be your best bet