Should You Prepay Your Mortgage In This Economy?

I wrote about Dave Ramsey’s Baby Step 6: Pay Off Home Early about a year ago, and I’d like to revisit the question of “Should you pay off your mortgage early?” in light of today’s economic crisis. In the Dave Ramsey article, I examined both the advantages and disadvantages of paying off your home loan early, but I didn’t give a definitive answer, because I believed, and still believe, that each person will have to decide on their own based on their unique situation.

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Mortgage Prepayment Doesn’t Make Sense In Bad Economy

However, I can now say for certain that I am fully opposed the idea of prepaying your mortgage without paying it off completely because there are several related factors that make this a bad idea. In this discussion, I’ll assume that you’re relatively debt free; otherwise, prepaying your mortgage doesn’t make sense in the first place.

Another note, the point I am making in this article is specific to someone who has a fixed mortgage loan and has a large enough balance that they cannot pay off the loan in the short-term by prepaying — i.e., prepaying to reduce interest expenses. This is a clarification based on the first two comments below.

Unexpected Job Loss

I expect things to get worse over the next 12 months and unemployment rate will continue to rise — yes, despite the economic stimulus package that President Obama just signed into law. As such, I think any extra money that you may have should go toward your emergency fund as opposed to mortgage prepayment.

If you have 3 to 6 months worth of living expenses in your emergency fund before, now is the time to beef it up to 12 months.  Why such a big jump all of the sudden? I think the greater margin of safety is needed because it’s now much harder to get a decent job than it was a year ago. Even the most skilled workers could go unemployed in this economy for many months.

Although the interest rates continue to drop, I think high yield savings account is still the best place to keep your money due to liquidity and preservation of principal.

Great Time To Invest

If your emergency fund is already in good shape, then I think investing your extra money in the stock market right now will give you better result in the long-term. Sure the real estate market price is depressed, but the stock market is nearly 50% off its high. So if you are looking for a “buy low” opportunity, this is it. Aside from buying at a deeper discount, I also think that the stock market will recover faster than the real estate market.

I think a Vanguard Target Retirement Fund is a great way to catch the market rebound. It’s simple, low cost, and globally diversified.

Conclusion

There may be other reason why paying off your home mortgage right now doesn’t make sense, but I think these two reasons alone are enough to make a strong case for not doing so. Sure, some of you may say that paying off your mortgage early gives you the best return on investment right now, and that’s probably true. But remember this, prepaying doesn’t buy you any favor with your mortgage lender. If you found yourself unable to pay your mortgage one day, all the money you paid early won’t make any difference.

What’s your thought on paying off your mortgage early? Do you think it makes sense in this economy?

About the Author

By , on Feb 18, 2009
Pinyo
Pinyo is the owner of Moolanomy Personal Finance. He is a licensed Realtor specializing in residential homes in the Northern Virginia area. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, and financial literacy author.

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Leave Your Comment (82 Comments)

  1. John says:

    My 401k mutual funds performance last year was 3%, my pension fund which is a single life annuity was 6%. I did withdraw funds from my IRA a couple of years ago, paid my mortgage off, and I do not regret it. Peace of mind, and I am not stressed out in my daily job at work. Calculate all you want, but it the same in the stock market as anything else, no one has a crystal ball that can tell what the future has in store for us.

  2. John says:

    My opinion, is to pay the mortgage off. It’s peace of mind, knowing your home is paid for.

  3. Pinyo says:

    Matt – If you can sell your stocks and don’t have to pay too much taxes or penalty, I think your idea is reasonable. However, I don’t know how many years you have left on your mortgage or your interest rate, so you might not be saving all that much money on the interest.

  4. Matt says:

    I only owe $65,000 on my mortgage. I’m 45, solid job, good health and 6 month emergency fund. My only other debt aside from monthly bills is a (small) boat payment. (mid-life crisis) I have enough company stock that I can sell, pay off the house in one lump sum and still have some left over. My thinking is this.
    1. I would have a place to live, no matter what. (barring an act of God, health issues, etc.)
    2. I could use the money from the mortgage and my car note to increase my emergency fund by several months.
    3. Then I could use the majority of my monthly income to aggressively fund my 401k.
    4. If I do decide to move, it’s becoming a rental heavy area. I could then rent the place out and let this house pay for most of the note in a better area or apartment rent if I’m relocated.

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