Four Hidden Reasons to Never Borrow From Your Retirement Plan

If you need money and you have money in your retirement account, it can be very tempting to borrow from it. It is your money after all.

Most retirement plans allow participants to borrow against their balances. About one in five 401(k) participants have an outstanding loan, and over a five-year period, almost 40 percent of participants borrow from their account at some point. Most loans are taken to pay off debt, usually of the credit card variety.

That can make some sense, since the loan rate on a 401(k) loan is lower than rates on credit cards. But there are other costs beyond the interest rate. While you are essentially borrowing from yourself, there are several consequences to taking the loan that make this a bad idea.

  1. While your loan is outstanding, your money is not invested in the market. You are earning the interest on the loan to yourself, but you are missing out on the greater growth you could get from stock market-oriented investments. The market rate of return is the true cost of your loan. Historically the stock market has returned on average 10 percent per year.
  2. Some employers don’t allow you to make contributions while you have a loan outstanding. If that is the case with your plan, you will miss out on the opportunity to grow your retirement account balance. If your employer matches contributions, you will also miss out on that.
  3. Your loan is repaid with after-tax dollars. When you retire, the money you repaid, like the rest of your balance, will be taxed when you take it out to meet your living expenses. So your loan will be taxed twice.
  4. If you leave or are let go from your job, you will only have sixty days to repay the loan or it will be considered a distribution. The distribution will be taxed as ordinary income in the year you take it, and you will pay an additional 10 percent penalty.

Instead of taking out a loan from your retirement account, consider what other options you have. If you are consolidating debt, have you considered taking advantage of a zero or low interest promotion on a credit card? Instead of adding to your debt, can you reduce your spending either by cutting discretionary expenses or by making bigger changes to lower the cost of where you live or how you get around?

In some cases, a loan on your retirement account may be the best of a few bad options, but that doesn’t make it a good one. There are costs that aren’t obvious, and they put you at risk of a big tax bill if you lose your job.

Photo by Ehud Neuhaus on Unsplash

Love and Student Loans: 4 Tips to Make it Work

So you’ve found your perfect match. He’s funny, kind and hard-working. You love doing the same things, especially together. But after finishing grad school, he has a mountain of student loan debt. Is he still the one?

These days 17 percent of student borrowers have more than $50,000 in debt. That debt load comes with repercussions. The payments will crowd out the other uses for your money, and the financial strain could lead to relationship strain.

Using a standard ten year repayment plan, monthly payments will be over $500 per month on a balance of $50,000. That is a big bite out of anyone’s salary. However, most who have that level of debt choose an extended repayment plan to lower the payments. Using a 25 year repayment schedule, the payment will decline to $331 per month.

In ten years, 65 percent of the loan will still be outstanding, and by the time the loan is fully repaid you will have paid interest equal to the amount of the loan. So for a $50,000 loan, $50,000 in interest will also be paid.

Generally those with graduate degrees have higher paying jobs, making it easier to handle the burden of the payment. But it’s not always the case. Now more and more, undergraduates are leaving school with high debt balances without the higher professional salaries.

The payments and the length of time they hang around will make reaching your other goals more challenging. The loan payments will reduce the amount you can afford to spend on housing, daycare, vacations and more. They will make it more difficult to save for retirement and college for your own kids. You will need to have a larger emergency fund to cover the debt payments, and it could be harder to qualify for a mortgage.

It’s no wonder that a significant number said they wouldn’t marry someone until their debt was paid off. If your partner-to-be has significant debt, you need to go into the marriage with your eyes wide open. Here are a few tips to make sure your relationship can handle the extra burden.

  1. Openly discuss the debt.
  2. Understand that as a couple you will be paying off the loan together. If your partner has to give up something to pay off the debt, you’ll be giving it up too. For example, if he puts less into retirement savings, you’ll both have less to retire on.
  3. Agree on how you will adjust your lifestyle to fit in paying off the debt and meeting your other financial goals.
  4. Pay down the debt as quickly as you can. Avoid repayment plans that allow you to pay less than the interest owed even if you qualify for them. If you pay less than the interest owed, your loan balance will grow every month. You are essentially borrowing more with every payment.

Debt can put a strain on any relationship. If you are diving into a new one with debt hanging over your heads, know what you are in for. Don’t believe the debt is your partner’s problem. It’s yours too if you go forward. But if you work together, you can still accomplish your financial goals.

Don’t Gloss Over the Cost of College

If you have a high school junior at home, you may have spent the week of spring break touring a few college campuses. It’s the perfect time to kick off the college selection process with your prospective college student.

You want the world to be your child’s oyster, and no one wants to talk about expenses when dreaming about the future. However, as you reflect upon the tours, it is a good time to bring a dose of reality into the equation.

College is expensive no matter where your child chooses to go, but some choices will set you back farther than others. The following chart shows the average cost of college for the 2017-2018 school year from the College Board.

Average Cost of College

While most parents want to send there children to college, only about 57 percent of them save for it. The average household savings for college was only $16,380, according to Sallie Mae. That means the money must come from somewhere else. The following chart shows how America pays for college, also from Sallie Mae.

How America Pays for College

A full 28 percent of the cost of college will be paid for with loans. The average student loan debt per borrower from the class of 2016 was $27,975. At the current Federal Direct student loan interest rate of 4.45% for undergraduates, over the standard 10 year repayment period, payments on loans of that amount will be about $289 per month.

That can be a significant piece of a new graduate’s entry level job income. It’s no wonder that 30 percent of college graduates with student debt move back in with their parents. With money like this on the line, it is important to sit down with your future college student and cover the facts.

Here are five things to discuss with your child before she chooses a school.

  • Tell your student how much you will be able to pay. This includes what you have saved and what you are willing to commit to out of your income. The converse of this is how much should she expect to pay. Only 70 percent of parents of teenagers have discussed their expectations with their child.
  • Outline options for raising the extra money. In addition to student loans and scholarships, your student may be able to raise some money through part-time or full-time work. Taking a gap year to work and save up for school is a reasonable approach.
  • Help your student understand the implications of their choices. Student loans may be hard to avoid, but they can certainly be minimized if you understand your trade-offs. You can calculate the monthly payments given different loan amounts on the Federal Student Aid web site.
  • Provide context for the information. Estimate the kind of monthly salary your student might earn given her career interests. Payscale’s College Salary Report is a good place to start. It wouldn’t hurt to also talk about average living expenses. Career Trends has a cost of living calculator. Don’t forget to show the impact of taxes. How much of her take home pay will be left after student loan payments?
  • Consider starting school at a community college. The average cost per year at public two year colleges is only $3,570 assuming your student can stay at home while she attends.

If you don’t have enough saved to pay for college, think carefully about the impact of paying for school out of your current income. If you are behind in saving for your own retirement, paying for college should not be your top priority. Your child has time to recover from the expenses of school. You do not.

A college education can substantially improve your child’s ability to earn a living. But taking on a lot of debt to pay for it can weaken her financial stability. Help her understand that her choices have implications for her lifestyle after school. Before she makes her final decision, she should know what she’s in for.


Your Credit Score Demystified

Credit scores are an important number. They will determine whether you can get a loan and how much interest you will pay. They can also determine whether you can rent an apartment, and it is becoming more common for employers to check your credit score before they hire you.

Unfortunately, the credit score carries a lot of mystery and mythology for many. So, in this post, you’ll learn all you need to know about them.

The credit score was invented in the 1950s by the Fair Isaac Corporation. It didn’t catch on initially as a tool, but in 1970, the Fair Credit Reporting Act was passed, which standardized data collection and reporting. The FICO score (from the Fair Isaac Corp initials) gradually gained prominence as a tool for assessing credit worthiness from there.

Your credit score has five factors, each weighted according to their importance in determining whether you are likely to repay your loan. The following table summarizes the factors, weights and what they scores

The biggest factor in determining your credit score is your payment history. So the most important thing you can do to raise your credit score is to make your payments on time. The second biggest factor is how much debt you have outstanding, and the next easiest way to improve your score is to pay down your debt.

Opening and closing accounts can have an impact on your score by shortening the average length of time your accounts have been open, but it will be minor compared to whether your payment history is strong and your balance is manageable.

A friend, who tries to maximize her travel rewards to minimize the cost of travel, opens credit card accounts for the bonus miles and then cancels them once she has what she’s after. She continues to have a stellar credit score, because she always pays on time and never carries a balance. If you have paid off a credit card balance, don’t hesitate to close the account if you no longer use the card.

Checking your credit score has no impact on it. While credit checks to establish new accounts can influence your score under the new credit factor, simply getting a credit report or viewing your score on-line does not change your score.

Regularly reviewing your credit report is an important defense against fraudulent activity in your name. I recently found a credit card account I had not opened on my credit report. Through a little correspondence with the credit agency and the lender I was able to get the account shut down. Debt established in your name is payable by you unless you actively work to close down accounts you didn’t open.

You can actually live without a credit score. If you are committed to living debt free, a credit score is not necessary. Even if you want to get a mortgage, but have no other debt, you don’t need to open some credit card or buy your next sofa on credit to establish a credit history. The things you do all the time will be enough.

If you pay your rent, utilities, cell phone and other bills, on time, and you have a down payment, you have what you need to get a mortgage. However, without a credit score, you may need to work with a smaller mortgage lender and allow more time. The larger lenders like the efficiency of seeing your character summarized in a single number.

Credit unions, independent mortgage brokers, on-line lenders and smaller banks may all be willing to provide the customer service needed to assess your credit worthiness without a credit score.  You can get pre-approved before you go house hunting and still be ready to jump on the perfect place when you see it.

You won’t be negatively impacted by having no credit score with other credit checkers. Having no credit score means you have no debt, which is a profound statement these days. Your future landlords will be happy to review your history with prior landlords. Employers looking to judge your character by your credit score will get the information they need by its absence. Certainly no score is much better than a bad one.

Your credit score is an important number, and the best ways to keep it strong are to pay your bills on time and pay down your debt. If you can accomplish that, the other factors play a minor role. You can live without a credit score, so don’t take on debt simply to establish one.

Fight Credit Card Debt with a Credit Card

Welcome to 2018. Now that the Christmas decorations are put away, the champagne has been sipped and the resolutions made, it is time to get down to business. If one of your resolutions was to pay down your credit card debt, there is a tool you may not have considered that can give you a leg up. It’s another credit card.

No, I usually don’t endorse opening new credit cards. You’ve got enough trouble with the ones you have. However, if you are truly committed, a card where you don’t have to pay interest will juice up your debt reduction efforts for any payment amount you intend. The reason is more of your payment will go directly to reduce your balance and less to interest.

Some credit cards offer a balance transfer feature with a zero percent interest promotion for the first 12 to 21 months, depending on the card. If you transfer your balance from another high interest card, you won’t incur interest during that promotional period. That means your entire payment will go to pay down your balance.

The cards generally have a 3.0 to 5.0 percent balance transfer fee. But compared to the high average annual rate charged on a typical credit card, it may be well worth it.

A survey done by U.S. News and World Report, found that most credit card holders who carry a balance had not used zero interest credit cards to reduce the cost of their debt, and two thirds thought they could pay off their balance within 18 months, a typical promotional period.

The following table shows how transferring a $3,000 balance from a typical credit card, with a 16.0 percent interest rate, to a card with a zero interest introductory rate could save you money and get you out of debt faster. With a $200 monthly payment, the balance is paid off two months earlier on a zero interest card, and you save $277 in interest, after the balance transfer fee.

Zero Interest Credit Card

There are some pitfalls, and not all cards are created equal. The first area of concern is which transactions get the zero interest treatment. For some cards, it is only new purchases, and for others it is only the balance transfer. Since you are trying to reduce your debt, you want zero interest on the balance you transfer.

Avoid making new purchases on your card. If you make additional charges, it can hamper your debt reduction efforts. When a card charges different interest rates on different transactions, regulations require payments above the minimum be applied to the balance with the highest interest rate. That means your extra payments will pay off your new purchases before they go to pay off the balance you are working on.

The financial institutions issuing these cards have no mercy when it comes to late payments. If a payment is late during the zero interest period, you may lose the zero interest benefit, and your rate will bounce up to the current new purchase rate. As a result, you will have paid the transfer fee for no reason.

Finally, if you are unable to fully pay off the balance you transferred within the promotional period, you may have to pay deferred interest on the balance remaining. That means your remaining balance will be charged the new purchase interest rate for the full introductory period at the end of that period.

U.S. News has a good comparison of the top balance transfer cards. In addition they provide a more in-depth guide to determining whether a new credit card is the right move for you.

Before you embark on this debt reduction mission, make sure you are working on the right priority. Debt reduction is not the first step on your road to financial security. Your emergency fund is. Don’t make extra payments on your debt until you have built up at least three months of living expenses in savings.

Debt reduction should also wait until you can manage it as well as a contribution to your company retirement savings plan large enough to get the company match. The company match is free money. Or, put another way, it provides a 100 percent return on your contribution. Debt reduction saves you a lot, but not nearly 100 percent.

Eliminating your high interest credit card debt is an important goal. If you have an emergency fund in place and you are getting your full company match in your retirement savings plan, it is the next thing you should be working on. Taking advantage of a zero interest credit card, can make your efforts even more effective. For at least a short time, your payments will go directly and fully to reducing your balance.

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The 12 Days of Financial Security for Christmas


Forget the birds and performing artists. These are the 12 gifts of financial security!

On the first day of Christmas my true love gave to me a fund for emergencies

On the second day of Christmas my true love gave to me a budget for expenses and a fund for emergencies

On the third day of Christmas my true love gave to me a maxed out retirement, a budget for expenses and a fund for emergencies

On the fourth day of Christmas my true love gave to me a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies

On the fifth day of Christmas my true love gave to me a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies

On the sixth day of Christmas my true love gave to me full estate planning, a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies

On the seventh day of Christmas my true love gave to me insurance for disabilities, full estate planning, a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies

On the eighth day of Christmas my true love gave to me a 529 for my kids, insurance for disabilities, full estate planning, a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies

On the ninth day of Christmas my true love gave to me a pay-down on my student loans, a 529 for my kids, insurance for disabilities, full estate planning, a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies

On the tenth day of Christmas my true love gave to me a sound investment strategy, a pay-down on my student loans, a 529 for my kids, insurance for disabilities, full estate planning, a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies.

On the eleventh day of Christmas my true love gave to me a long-term care policy, a sound investment strategy, a pay-down on my student loans, a 529 for my kids, insurance for disabilities, full estate planning, a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies.

On the twelfth day of Christmas my true love gave to me, a pledge to be mortgage free, a long-term care policy, a sound investment strategy, a pay-down on my student loans, a 529 for my kids, insurance for disabilities, full estate planning, a Roth IRA, a pay-down on my visa, a maxed out retirement, a budget for expenses and a fund for emergencies.

Merry Christmas everyone!

How Much Mortgage Loan Can You Afford?

When my husband, Jeff, and I were in the market for our current home, we took the steps you usually do to make sure we could jump on our dream home should we find it. The biggest part of that was getting pre-approved for a mortgage loan. After submitting all our information to the bank, we got back an approved loan amount that was frankly shocking. There was no way we could afford a mortgage payment that high. What were they thinking?

The amount of loan that you qualify for and the amount of loan you can afford are two different things. In expensive housing markets, like Portland, Seattle, San Francisco and others it’s tempting to spend as much on a home as the bank is willing to lend you, because your dollar just doesn’t go very far in these cities. But that can take away all your financial flexibility and ultimately your financial security.

You may be thinking if a bank is willing to lend you the money, you must be able to afford it. But the bank doesn’t really care about your other goals or even your financial security. They only care that you can make the payment, and they have a formula that gives them confidence you can. The formula is the debt to income ratio, and it is the biggest factor in determining how much money the bank is willing to lend you.

The debt to income ratio is your monthly debt payments divided by your gross monthly income (your income before taxes). Banks generally cap your debt to income ratio including the mortgage payment at 43 percent. Other factors like your credit score and down payment will influence whether they will lend the full 43 percent. But if you have a good credit score and can put at least 10 percent down, you will likely be eligible for the maximum loan amount.

Suppose that you and your partner make $108,000 per year between the two of you. You also pay $1,000 per month in student and car loans. Here is what your current debt to income ratio would be:

Debt to Income

How much mortgage will your bank lend you? Your current debt to income ratio is 11 percent. Assuming that you have good credit and a 10 percent down payment, your debt to income ratio could increase by 32 percent.  That allows for a total monthly mortgage payment, including taxes and insurance, of about $2,850. The bank will likely lend you around $450,000, using today’s interest rates on a thirty year mortgage of 3.63 percent and average property taxes and insurance rates in Portland, Oregon.  The value of the home would be $500,000.

Can you afford that? Let’s see. The following table estimates your monthly take home pay and how much you’ll have left to live on after all your debt payments.

mortgage paymentYour total debt payments take up almost 70 percent of your take home pay. The money remaining after just making your debt payments is less than $2,000. That puts you in a precarious position. If either you or your partner loses your job, you won’t be able to cover all your payments.

The size of your debt payments drive the size of the emergency savings you need to set aside. You won’t be able to reduce your expenses if you lose one of your incomes with payments like these. If both you and your partner make about the same amount of money, you will need to have at least $8,500 in emergency savings. You’ll need even more, if one of you makes more than the other. You should also have enough additional savings to cover your health care plan deductible.

But even if you have emergency savings, the payment is more than you can afford. You will inevitably have maintenance and repair expenses on the home you just bought. The more expensive the home, the larger those bills will be. Some of your remaining income will need to be set aside for that.

A good rule of thumb for maintenance and repair is $1 per square foot. In Portland, a house in this price range will be about 2,500 square feet, so you would want to set aside $2,500 per year or $208 per month and hope nothing needs fixing right away.

This example assumes you are saving 5 percent of your pay for retirement, which isn’t nearly enough. The longer you wait to save more the greater the portion of your income that will need to go to savings. If you’re still in your twenties, you can get away with saving 10 to 15 percent of your pay (around $1,000 per month). But if you are in your thirties, and don’t have current retirement savings, you should be saving 20 to 30 percent of your pay (more than you have left).

And what about your other financial goals? There is no room for them, whatever they may be. With this mortgage, about all you’ll be able to do is make the payments.

Instead of letting your bank tell you how much you can borrow, you need to figure out how much you can afford while still working toward your other financial goals. To keep your monthly obligations at a more comfortable level, your total debt payments should be no higher than 25 percent of your income.

With the income in the example, that allows for total debt payments of $2,250, and a mortgage payment (including taxes and insurance) of $1,250. That translates to a mortgage of $206,000 and a home value of $229,000 with 10 percent down. That’s just a bit more than half what the mortgage company was willing to lend you.

To estimate how much loan you can get away with given the payment you can afford, try this loan calculator. This calculator only provides the loan amount, and doesn’t include taxes and insurance, so you’ll want to leave room for those. However, it’s a good place to start.

Houses are expensive. Their true cost is much more than the monthly mortgage payment, and you have other goals beyond owning a home. Controlling your housing costs is one of the best ways to ensure you can meet those other goals. Base the house you buy on what you can afford, not what your bank is willing to lend you.

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The Monster Lurking in Your Bills

What creeps up on you without you even being aware? It gradually but surely takes away your freedoms and keeps you from doing the things that are important for your future. It takes away your sense of security and control. This evil monster is debt.

Debt is an insidious thing. While it lubricates the gears of society and allows you to accomplish things that would otherwise be difficult, it can undermine your financial security and your ability to reach your financial goals. Here’s how it happens.

The Student Loans

You and your partner went back to school to get your master’s degree a while back. Between the two of you, you still have almost $60,000 in student loan debt. It was important to go back to school so you could make the next step in your careers, and while that debt will help you earn more, the payments are over $600 per month.

The Mortgage

You move out to the suburbs and buy the house of your dreams. It’s a little bigger than you need, but the agent said it would be a good investment. Your mortgage company didn’t hesitate to make you the loan, so they must think you’re good for the payments. Your mortgage alone is $1,800 per month. Taxes and insurance add another $700, taking you up to an even $2,500.

The New Car

Your local car dealership is offering a no-interest loan on a new car when you trade in your clunker. Your car is ten years old, so it’s about time for a new one. Your loan payment is $350 per month.

The Once in a Lifetime Trip

You had a big anniversary last summer, so you and your honey took a dream trip to Italy. You were inspired by the trip a coworker had taken. If your coworker could take a trip like that, of course you should be able to as well. And it was so romantic. The trip set you back $10,000, and you put it on your credit card. Since then you just haven’t been able to make a dent in the card balance. Your minimum credit card payment is $250 per month.

The Consequences

What are you up to now? Every month you are obligated to pay $3,700 in debt payments before you do anything else.  You don’t get to choose not to make those payments. Between the two of you, you make good money, but money feels tight.

After taxes and health insurance premiums you’re taking home about $4,700 per month. But that only leaves you $1,000 to pay for all of your other expenses. And you haven’t set anything aside for emergencies or your future retirement.

Paying your bills is all you think about. You juggle your payments between paychecks. You wait to send payments until the very last minute. You’ve over drafted your bank account twice this year. You’re starting to quarrel with your partner.

Debt has turned from something that provided an opportunity to something that is ruining your life. How could this be? The debt was taken on for good reasons. What else were you supposed to do?

Vanquishing the Monster

Debt can be minimized if you go at life with that intention. Student loans can be limited by working part time and living as cheaply as possible. Buying only the house that you need will reduce your mortgage payment and property taxes. And paying cash for everything else will go a long way toward growing your financial freedom.

But if the monster is already in your life, the only way to get rid of it is to pay the debt down. These are the steps.

  1. Create a budget. Include in your budget all the things that you spend money on monthly as well as an allocation for irregular expenses, like car or home repairs or uncovered health care expenses. Nearly all expenses are predictable if you sit down and think about the present as well as the future. Setting money aside for these expenses, that can be foreseen, but for which there isn’t a monthly bill, will help keep you from adding to your debt.
  2. Using your budget, cut back your non-debt spending wherever possible so that you have a little wiggle room. Stick to this new spending plan.
  3. Use your wiggle room to build some emergency savings. Your goal should be to save enough to cover your minimum living expenses for three months. If you have two incomes, you can get away with saving what the lower of the two won’t cover, but if there is only one, you’ll have to save enough to cover all those expenses. The emergency savings will keep you from adding to your debt in the event that you unexpectedly aren’t working.
  4. With your emergency savings in place, use the money you were saving toward it to begin attacking your debt. The debt snowball popularized by Dave Ramsey is a good approach.
    • Pay only the minimum payment on all outstanding loans except the one with the smallest balance.
    • Concentrate all the money freed up by making only the minimum payment and what was going toward your emergency savings to pay as much as you can on the smallest loan. The extra payments reduce the loan balance directly, and will allow you to pay down the loan faster.
    • Once that loan is paid off, move on to the next lowest balance and use all the money you were paying on the first loan to add to your payment on this loan.
    • Keep going in this way until you reach your mortgage payment.

Pay as much as you can. Don’t be discouraged if the amount is small. Every little bit makes a difference.

Don’t worry about the interest rate on the debt you are paying off. While you will pay more interest if you don’t pay down your high interest loans first, you will get out of debt faster by paying off your debt in the order of the balance. Getting out of debt faster will increase your financial flexibility, reduce the amount of emergency savings you need and allow you to make progress on your other financial goals.

Don’t worry about paying down your mortgage until your other debt is paid off, and you are fully meeting your monthly savings goals.

If your employer offers a match to your retirement plan contributions, it is important that you contribute at least enough to the plan to get it. Paying for your future life is one of those bills you need to be setting money aside for every month, and getting help from the company where you work will go a long way. Ideally you would do this before you begin the debt snowball.

Debt is a monster. If it has taken over your life, the only thing to do is to get rid of it. It won’t be easy. But if you lay out a budget, cut back your spending and pay as much toward your debt as possible, you will eventually win.

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Paying Off Your Mortgage is Worthwhile Despite Low Interest Rates

I often get asked whether you should pay off your mortgage early. In these times of low interest rates it doesn’t seem like you gain much when you do. For a number of reasons, paying down your mortgage shouldn’t be your first priority, but if you are otherwise out of debt, and you are meeting your retirement and other savings goals, paying off your mortgage should be next on the list.

Mortgage debt is the lowest cost form of consumer debt. Today a thirty year fixed rate mortgage will cost you about 4.3 percent and the 15 year mortgage will cost you about 3.5 percent. If you happened to buy your home when rates were at their lowest, your interest rate could be as low as 3.3 percent. When you tack on the mortgage interest tax deduction the rate is even lower. The following table shows before and after tax mortgage interest rates.


With rates this low, paying off all other forms of debt is your top priority. And even though holding this debt on your home is costing you money, earnings on your retirement savings out weigh the benefits of paying off your mortgage early. But if you are on track for saving for retirement, and don’t have any other debt, paying down your mortgage is a good next step.

Mortgage vs Investing

Paying down debt is a form of saving, and it provides a guaranteed rate of return. Every dollar you pay, you reduce the amount of interest you pay. Even though mortgage rates are low, they still offer a relatively high rate of return for risk free investments. One year Treasury bonds yield less than 1.0 percent. CDs offer similar returns. Slightly riskier fixed income investments, like one year corporate bonds, only pay a little more than 1.0 percent. But on every dollar of mortgage interest you avoid you earn your mortgage interest rate.

Yes there are riskier investments that have higher expected returns. Historically, the average stock market return has been 10 percent. Wouldn’t that be a better place for your money than paying down your mortgage? For your retirement savings goals yes. Those are very long term goals. But if you are meeting those goals, it’s worth considering the relative risk of investing in the stock market versus paying down your mortgage.

If you choose to invest in the stock market with your next savings dollar, rather than pay down your mortgage, you are essentially borrowing money to make the investment, all be it at a very attractive interest rate. Your net return is the market return minus your mortgage interest rate. That would be an average return of less than 6 percent at today’s mortgage rates. Not much more than the guaranteed return of paying down your mortgage, but with a lot more risk. Your actual return in the stock market fluctuates widely from year to year. It only has to dip down to 4.0 percent to give you a negative return after your mortgage interest. That has happened in about four of every ten years.

Mortgage vs Security

While we can quibble about the attractiveness of a higher risky return versus a lower, but attractive, risk free return, one thing is certain. Eliminating all forms of debt makes you more financially secure. That is particularly important when you aren’t getting a paycheck. If your scheduled mortgage payments would have you continuing to make payments beyond your retirement date, it is important that you find a way to eliminate your mortgage before you stop working.

According the Consumer Financial Protection Bureau, in 2011, those over the age of 65 who owned their home and still had a mortgage were paying nearly three times what those without a mortgage were paying for housing. With no mortgage payments, your draw on your savings will be smaller, making them last longer. If your savings have suffered from an investment market downturn, you will be better able to weather it, because your overall expenses will be lower.

Compare two women, Valerie and Jocelyn. Both are single and recently retired. Valerie has a pension from her government job, while Jocelyn has retirement savings. Both women will have about the same amount to live on, around $4,000 per month.

Valerie, due to a recent divorce, will have to take on a mortgage of around $100,000. Her payments will be at least $500 per month excluding taxes and insurance.  With the new mortgage payment, Valerie’s expenses will consume all of her income. As other expenses increase with inflation, Valerie may find herself pinched and need to find ways to cut back on her lifestyle. Jocelyn’s home is paid off, and as a result she has much more financial flexibility. Her cost of living is low and has plenty of room to grow if inflation forces it up. Jocelyn is much more financially secure than Valerie.

We are lucky to live in an era of low mortgage interest rates. It makes the cost of housing more affordable. So paying off your mortgage, unlike other forms of debt, doesn’t need to be a priority. But when you run out of other savings goals to fulfill, paying off your mortgage is well worth it. It’s hard to find a better guaranteed rate of return and getting rid of your mortgage payment before you stop working for pay will make you more financially secure.

Image courtesy of Stuart Miles at

Black Friday Can Lead to a Red Bottom Line

If “Black Friday” is  the first day of the year the retail industry breaks even, it may also be the first day you go into the red for the holidays. The retail industry has been hard at work pumping up sales since Halloween, but the true frenzy begins on Friday. In it’s October survey, The National Retail Federation found that Americans are planning to spend an average of $935 per person this shopping season, up 16 percent from last year’s survey. If history repeats, much of that spending will be paid for with debt.

From another survey by Magnify Money, those who used debt to pay for their holidays added $986 to their debt load. Most people expected to take more than five months to pay off the shopping spree, with a substantial number planning to make only the minimum monthly payment. Assuming the average credit card interest rate reported by the Federal Reserve Bank of 13.76%, if you take 5 months to pay off this new balance, you’ll pay about an extra $34 for what you buy. If you make only the minimum payments, you’ll be paying for more than five years and pay an extra $315 for what you buy. To figure out how your credit card debt and payment plans will pan out, check out this calculator on

Gift giving and entertaining are an integral part of the season in our culture. It’s an emotional time, and it is easy to get carried away with spending. That can spill over and get in the way of meeting your financial goals. The best way to avoid having the holidays be the next financial hole you have to fill is to start with and stick to a plan.

  1. Create an overall budget for your holiday spending before you begin shopping. Allocate the budget among your recipients, i.e., $50 for Mom, $35 for Aunt Jean. You get the picture. Not all of your spending will be on gifts. Make sure you account for the extra cost of holiday meals and/or parties. Ideally, your budget will not cause you to add to your debt.
  2. Decide ahead of time what you will buy for as many gifts as possible. If you know what you are going to buy, you can more easily shop for the best value, and you are less likely to spend more than your budget.
  3. Internet shopping can be a great approach, since you may be less tempted to impulse buy. Many internet retailers are offering free shipping for the holidays.
  4. By all means if what is on your list is on sale, take advantage. But if you have to buy more than you need or something you don’t need at all to get the discount, pass on the sale.

Perhaps you are part of a family of competitive gift givers. You may feel your gifts have to live up to the gifts your family give you. If this is making it hard for you to keep a reasonable budget, consider having a discussion with your family. Stop the cycle by setting a cap on the price of gifts, and/or limiting the number of gifts by assigning one or a couple of family members to each person, secret Santa style.

You can reduce the cost of the gifts you give by making them as well. When my daughter Kaye was three, we started a tradition of making gifts for Kaye to give to family and friends. I didn’t want to just go buy gifts and give them in her name. I wanted her to participate in the giving, and at three, her budget wasn’t very big. The first gifts we made were hand print flower pictures, and some are still hanging on the walls in family members’ homes.

We did several projects over the years, but since she’s gotten older, we’ve settled into baking for Christmas. One year we made 1,000 cookies. While for most people we know there isn’t a single thing that I could buy them that would hold much meaning, our cookies are legendary. Our friends and family look forward to getting them every year.

There is a lot of pressure to overspend during the holidays. What would the holidays be without a chance to gather with those we love and brighten their day with a thoughtful gift. But don’t let the holidays derail your financial plans. Setting a budget and planning before you shop can keep your holiday spending from getting out of hand.

Image courtesy of samuiblue at

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