This week, the Federal Reserve reaffirmed its intention to stop buying mortgage-backed securities at the end of March, signaling the likelihood that the mortgage rates you can get today are as good as they're going to be for a long while - and will probably rise into the summer and fall - perhaps putting more downward pressure on home prices.
The current rates are quite good. At about 5 percent, in fact, they're so good that they've helped change the age-old debate over whether homeowners should make extra mortgage payments to pay off their debt well before their loan periods are up.
Back when rates ran at 7 or 8 percent, making extra payments offered what amounted to a guaranteed return on your money.
At a time when just about everyone knows someone who is unemployed or who owes more on a home loan than the house is worth, not paying down the mortgage quickly (making extra payments) seems like a safer approach.
Don't even think about making extra mortgage payments unless you've paid off higher-interest debt.
Also, if you're not saving enough to get the full match from your employer in a 401(k) or Roth IRA, increase your savings there first. And don't make extra mortgage payments if you don't already have a decent emergency fund set aside.
Let's say you have a household income of $175,000 and are paying 35 percent of that in total to the state and federal tax collectors. If you pay $20,000 in mortgage interest each year on a loan that charges 5 percent, the deduction effectively brings your taxable income down to $155,000.
As a result, you're paying $7,000 (35 percent of $20,000) less in taxes than you would have without the deduction. So ultimately, you're not really paying $20,000 in interest at all; your net cost is $13,000 after you subtract the $7,000 tax savings.
And that makes your effective, after-tax interest rate on your loan just 3.25 percent, which is simply 35 percent (your tax rate) less than the original 5 percent.
So any money you set aside in lieu of making extra mortgage payments would need to earn more than 3.25 percent annually.
Vanguard Wellington (VWELX), for instance, a popular low-cost mutual fund that holds about 65 percent stocks and 35 percent bonds and other short-term securities, earned an average annual return of 6.15 percent in the 10 years ended Dec. 31, 2009.
Then you need to preserve those savings. When extra money goes toward a mortgage, it's hard to get at it when the urge strikes to flee to an Asian beach for a few weeks of playtime. If the money is not locked up in retirement or college savings, however, you may be tempted to spend it.
Capital-gains taxes might eventually come due with some of these investments, and the rate could well rise above the current 15 percent long-term rate before too long. Still, having some of your savings in a taxable account makes sense for several reasons.
If you hit a stretch of long-term unemployment after having plowed most of your extra cash into paying down your mortgage, your bank probably won't pat you on the back for being a good saver and give the money back to you. Nor is it likely to let you borrow it through a home equity loan if you have no income with which to repay it.
If you've just started paying down your mortgage, any extra payments should go toward principal (make sure your mortgage company is applying it properly). That will have the effect of shortening the term of your loan from, say, 30 to 25 years, depending on how many extra payments you make. The extra payments won't lower your monthly payment, but they will reduce your balance. You end up going down the amortization curve more quickly. It is especially beneficial in the early years of a loan...
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