Should you pay off your mortgage early? Think it through first

There's no doubt that saying goodbye to mortgage payments is a wonderful moment. Yet I am wary of this financial strategy for most people.

The questions that preoccupy readers tend to come in waves. For instance, toward the end of the last year many folks wrote in with queries about Roth IRA conversions for 2010. Earlier this year, a theme was the search for extremely safe investments that still paid a decent yield. (Alas, there's no way around the trade-off between risk and reward.) Lately, the focus is on the wisdom of aggressively paying down the mortgage, say, over four to seven years.

The reasoning usually runs along these lines. I'm earning almost nothing on my savings. I can get the equivalent of a 5 percent or so return on my money by paying down the mortgage. I want to own my home free and clear as quickly as possible.

There's no doubt that saying goodbye to mortgage payments is a wonderful moment. Yet I am wary of this financial strategy for most people. To be clear, it's a great idea to add an extra monthly mortgage payment every year (pretending there are 13 months a year) or adopting a biweekly repayment schedule. These financial tactics are money-smart. Your overall interest tab shrinks, and you build up equity faster. And they are also relatively painless financially. No, I'm addressing the trade-offs with the pedal-to-the-metal mortgage pay-down strategy.

And there are trade-offs to consider. For one thing, over the next several years you're putting most of your financial eggs into one asset -- a home. Your financial health will be more dependent than before on how that asset performs in coming years. You're already highly exposed to the local economy through your jobs. In a sense, you're doubling down that bet on local conditions.

There are other important savings goals to strive for in an uncertain economy. Are you carrying any credit-card debt or an auto loan? Get rid of those debts. Are you putting the maximum into retirement savings plans? If not, I'd do so now. Is there enough money in savings accounts and money market funds to get you through a spell of unemployment or a medical emergency? We all struggle to meet some or all of these savings goals. That's why I recommend people focus on paying down their consumer debts and concentrate on building a well-diversified portfolio of cash, stocks and bonds first -- and not just in retirement savings accounts.

A related concern is what economists call "opportunity cost." Whenever you make a decision to do something -- like dramatically accelerating mortgage payments -- you foreclose using the money for other purposes.

The late Robert Eisner, an economist at Northwestern University, illustrated opportunity cost this way: The cost of buying and reading his book -- "The Misunderstood Economy'' -- was not only the dollars spent on it, but also the value of the time spent reading it and the alternative use of that time. In other words, his book should only be read if you believe your return, both in enlightenment and enjoyment, exceeds its opportunity cost -- that is, money spent on the book and the time required to read it.

The same goes with the mortgage payoff strategy. Your savings could go toward an investment opportunity opened up by the Great Recession or to fund a career change sometime in the near future. That said, with good savings habits, a home should shrink over time as a percentage of your total net worth. And then, by all means if you have the money, get rid of the mortgage.

Chris Farrell is economics editor for American Public Media's "Marketplace Money." Send questions to cfarrell@mpr.org.

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