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    Reader’s Question: Increase mortgage payments or 401(k) contributions?

    September 07, 2018

    Reader’s Question:

    My husband and I are both in our late-50s. We steadily contribute to our 401(k)s, but other than the equity in our home, we have no other real retirement savings.

    After recent salary increases (and with static monthly expenses), we’ve calculated that our discretionary monthly income is now almost $2,700.

    Scott, should we put all our discretionary income toward the mortgage, find some snazzy tech investment, or should we perhaps double our contributions to our 401(k)s?

    ~Mary

    Scott’s Answer:

    As you earn more money, it’s tempting to increase your spending in a way that devours your extra income.

    Good for you for not succumbing!

    You’ve come to a place where you’ve calculated your discretionary income and decided to direct it toward the future.

    But where should it go?

    First, Pay Off Your Consumer Debt

    Lots of people with great cash flow still carry credit card debt.

    Some people justify that debt by making chunk credit card payments, but never quite pay off the balances.

    While this frustrates me, I believe people live this way because paying big chunks of debt off each month makes it “feel” manageable.

    In Ernest Hemingway’s book, The Sun Also Rises, a character is asked how he went bankrupt. He replies: “Two ways. At first gradually, and then suddenly.”

    Simply, debt is manageable … until it isn’t.

    Second, Pay Off Your Cars or Any Recreational Vehicles

    Car loan interest rates are typically higher than mortgage rates, but even if they weren’t, unlike homes, cars neither appreciate in value nor can you deduct the interest.

    I often see people with tens-of-thousands in savings still paying $800 a month for two cars, when in no time at all they could eliminate those car payments and all the interest that comes with them.

    Imagine having an additional $800 a month to add to your discretionary $2,700, and saving hundreds in interest in the process.

    After Your Debts Are Paid

    Now, before I get into what you should do in the short term, whether debt free, or not, if you do nothing else, I would absolutely recommend that you calculate how much you need to increase your mortgage payments each month so that your house is completely paid off by the day you expect to retire.

    While that’s the long view, the following should be considered a guideline to spur you into action, and not a hard rule. There are numerous other things to consider and every situation is unique.

    I want you, if possible, to retire mortgage free. But there might be scenarios where you don’t increase your payments to eliminate that expense.

    First, when it comes to deciding between investing or paying down your mortgage, how would you answer the following questions:

    • How much is your home worth today?
    • What is your monthly mortgage payment?
    • How much of your home do you own?
    • How fast is the value of your home appreciating?
    • What’s your interest rate?
    • Do you expect to stay in this house after you retire?

    The next thing you have to ask yourself, is what would be your expected rate of return on any investment you might make?

    Is your picture any more clear?

    Or, rather, in what magic universe does a reasonable expectation of a return on an investment, plus risk, somehow dwarf both the return on your home’s appreciation and the increased cash flow and peace of mind that will come with retiring mortgage free?

    I would implore you to at least attend a free workshop before making a decision.

    Depending on certain personal financial factors (which I can’t know from your question), while I might advise you to place a good-sized chunk of that $2,700 a month toward paying off your house, I would especially make that recommendation, if:

    • You’re in a low tax bracket
    • Your interest rate on your mortgage is high(ish)
    • The balance on your mortgage is high(ish)
    • And, your investment risk tolerance is low(ish) (you dislike risk)

    It’s unlikely, but, depending on other circumstances, I might advise you to hold off on paying down your mortgage if:

    • You are under 50 (which you aren’t)
    • You have a high-investment risk tolerance
    • You’re in a high-tax bracket
    • You have an incredibly low 30-year fixed mortgage

    A Final Consideration

    Paying off your home in chunks may deplete your emergency savings. If all your reserves are in your house and your 401(k)s, that’s not optimum.

    Simply, before you put all your discretionary income toward the house, make sure you are debt free and that you have at least six months of reasonably-liquid cash savings to cover your bills in the event of an emergency.

    Conclusion

    In a perfect world, this is probably the sequence I would follow:

    • First, pay off all your consumer debt
    • Second, accumulate at least six months in emergency savings
    • Then, “up” the amount of your payments so that the day you retire you are mortgage-free
    • Put the rest into your 401(k)s, and consider reining in your risk

    Lastly, when you are five years from retirement, or if, due to a health emergency or a layoff, you are forced to suddenly stop working, schedule an appointment with a fiduciary advisor.
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