My grandmother died, and we just received about $20,000. We're wondering whether we should use the money to pay down our mortgage, or whether we should invest it.
These days, there's rarely any reason to rush to pay off the mortgage. If you locked in low rates over the past few years, then you generally can do better by investing the money.
The key is to compare your after-tax interest rates. Paying down a mortgage with a 5.75% rate, for example, is the same as an investment that earns 5.75%. And if you're deducting the mortgage interest in the 25% bracket, a 5.75% mortgage really costs you just 4.3% after the tax benefits (although you may have to pay taxes on your investment, too).
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Two other reasons to invest the money rather than paying down the mortgage: leverage and liquidity. You already benefit from all of the home's price appreciation, whether you have 10% or 100% equity. And money you keep outside of the mortgage is much easier to access. Paying more toward your mortgage one month does not give you any more flexibility to make lower payments in future months. It just helps you pay off the loan earlier, which still may be more than a decade away. After you use that money to make extra payments, you won't be able to touch it again unless you take out a home equity loan or sell the house. If you'd invested the money, on the other hand, it's generally easier to access if you do lose your job or have an emergency and need the extra cash to make future mortgage payments.
The extra payments may make more of a difference, however, if you're nearing retirement and closer to paying off the loan. "If they have $20,000 or $40,000 left on their mortgage, I would consider having them pay off the mortgage so they don't have to make that monthly payment and psychologically they feel good," says Michael Eisenberg, a CPA and personal financial specialist in West Los Angeles, Cal.
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