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Question for the Money Doctors

Question submitted on Apr 29, 2013.

Question

we have six months cash on hand + an extra $40,000. We have $75,000 left on our morgage. Would paying down the morgage with the $40,000 make sense or would it be best to "invest" it?

Answer

Deciding between prepaying your mortgage and investing your extra $40,000 isn't an easy decision because each option has advantages and disadvantages. The simple approach is to compare the interest rate you are paying on your mortgage with the returns that you might expect to get from an investment. For example, if you have a fixed rate mortgage of say 6.00% with 10 years remaining, what investment could you make to earn 6.00% over the next 10 years? How comfortable are you with the risk that you would be taking to earn that investment return?

Other considerations would include your marginal tax rate, your age or time horizon, and other financial obligations, such as education costs for children, and saving for retirement. Do you plan on staying in your home for many more years or do you plan on moving within the next couple of years? Does your mortgage have a prepayment penalty?

Did you earn and save the extra six months of cash and the extra $40,000 or did you inherit the money?

Generally, if you are the type of person who has six months of cash on hand and have managed to save an extra $40,000, you seem to have the discipline to manage your finances rather well. I would suggest that you consider investing the funds for retirement or some other specific goal. If you lack the discipline to save and invest, perhaps you should pay down your mortgage so that you don't spend the money and have nothing to show for it.

You can always do both by paying $20,000 down on your mortgage and investing $20,000. There is no incorrect answer. You must do whatever works for you given all the facts. Good luck!


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