Ask an Advisor: Should I Pay My Mortgage or Invest in CDs? I refinanced my mortgage at 2.375% but can I get a CD at 4%. I want to retire in 7 years.
I debated whether to pay my mortgage. I refinanced at 2.375% and can get a certificate of deposit (CD) for one year at 4%. I added to my mortgage payment by about $1,000 a month to pay it off in seven years instead of 14 years. I want to retire in seven years, and even though my Social Security will be about $3,500, and my husband is still working, I’m not sure that would be wise.
– January
Either you should pay off a mortgage first or invest more depends on what you hope to gain by choosing one over the other. It could be that you just want to choose the option that leaves you better financially. But you may want to consider the risks, the effect on your budget, and also purely non-financial factors.
Comparing your mortgage rate to the return on investment
Ask an Advisor: Should I Pay My Mortgage or Invest in CDs? I refinanced my mortgage at 2.375% but can I get a CD at 4%. I want to retire in 7 years.
Many people like to break down the decision of whether to pay their mortgage as a tradeoff between
the interest rate on their mortgage and the return they could have earned if they had invested that money instead.
The idea is that if they can earn a higher rate of return than what they pay in interest, they are better off. As a basis, this is a logical approach.
But another element of this decision is the risk associated with investments. For example, suppose the money is instead invested in a stock portfolio. Even in a well-diversified portfolio, there will be fluctuations in the value of that portfolio. The same element of risk is not present when you pay off a debt balance with a fixed interest rate. That’s because you know the amount you’re saving – it’s that fixed interest rate.
Therefore, the question evolves. You need to compare the interest rate on your mortgage to the rate of return can reasonably expectto earn on a portfolio that exposes you to an amount of risk that you are comfortable with. Your time horizon matters a lot in this analysis, and you should consider it. (This tool can help you connect with potential advisors as you navigate retirement.)
However, 2.375% is an incredibly low interest rate. It would be easy to make a mathematically sound argument for not paying off that balance earlier than you should. If you take the One year CD at 4%, this is a fixed rate, so you don’t have the same volatility considerations as you would with a longer term investment.
Just make sure you account for the tax implications. That CD interest is taxable. You can also get a tax deduction for the interest you pay on the mortgage.
Consider Your Retirement Preference
Ask an Advisor: Should I Pay My Mortgage or Invest in CDs? I refinanced my mortgage at 2.375% but can I get a CD at 4%. I want to retire in 7 years.
You may not want to base your decision solely on a mathematical comparison. Consider your preferences and emotions, especially as you look at your potential retirement in seven years.
Many people get a significant amount of satisfaction paying off their mortgages. Knowing that owning their home is attractive to them.
While you can’t put an exact dollar value on that satisfaction, you can approximate it. How? Just ask yourself if you’d rather have the amount you estimate you’ll have if you save that extra payment in seven years or a paid-off house.
For some people, that satisfaction and the relief it brings is worth a lot. They will choose a paid house over saving a large amount of money. For others, it’s not worth much. They can choose to keep the mortgage and invest more, although saving money only results in a small gain relative to the first payment. (This tool can help you connect with potential advisors as you navigate retirement.)
When people enter retirement and no longer receive paychecks, they tend to change their preference in favor of a paid-off home. It’s understandable, and not having a mortgage payment in retirement certainly increases the amount of flexibility in your budget. Imply in your question that this may be an important factor for you, or at least that it is in your mind.
Bottom line
Start with the mathematical comparison. From there, consider how much weight you want to give to those other factors. Finally, make your decision based on the totality of the situation.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers readers’ questions about personal finance and tax topics. Have a question you want answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAsset AMP platform, nor is he an employee of SmartAsset, and has been compensated for this article.
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