Financial priorities to tackle before paying down your mortgage

Are you anxious to pay down your mortgage? If so, you're not alone. According to a recent study, as of September 2013, consumers are once again prioritizing mortgage payments ahead of credit card payments. This reverses the trend of paying down credit card debt before mortgages, which started in 2008 during the mortgage crisis, notes the study, published by credit reporting agency Transunion.

Like many homeowners, you may think that paying off your mortgage as fast as possible takes precedence over other financial responsibilities, because it could save you money in interest. But is that really the best strategy for you?

That depends, says Jonathan Duong, CFA, CFP, president and founder of financial advisory firm Wealth Engineers, LLP.

"If you obtained your mortgage or refinanced within the last five years, your rate is almost certainly under 6 percent," he says. In addition, Duong says if you itemize your tax return, then the mortgage interest you pay is tax-deductible.

"This means that most people would be better off addressing their other financial goals and investing for the future rather than paying off a low interest rate mortgage," says Duong.

So before you mail in that extra mortgage payment, keep reading for a list of other financial priorities to consider.

Emergency Fund

All of our experts agree: An emergency fund is your number one financial priority.

"It's critical to have at least a few thousand in savings before you attack your other goals so that you have a cushion if the unexpected happens," says Duong.

And what could the unexpected look like? It could be a major car or home repair, which could cause big financial problems if you don't have an emergency fund, says Rob Drury, executive director of the Association of Christian Financial Advisors. Having money saved up in case these occasions arise is a form of risk management, he explains.

So how much should you save? In order to address the immediate cost of any unexpected need, you should save three to six months of income and make sure it's easy to get to when needed, says Drury.

"The key requirements for these funds are liquidity and safety," he says. "With that stated, it only makes sense to put the money where it earns the highest interest, as long as it remains safe and accessible." Drury says some online accounts currently offer higher rates than their brick-and-mortar competitors.

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Retirement Savings

In many cases, prioritizing your retirement savings should come right after emergency savings, especially if your employer offers matching contributions to your 401k or 403b plans, says Duong.

"This is free money," says Duong. He says that this often equates to a 50 to 100 percent return on your investment. "You won't find a better return anywhere," he says.

Drury says that retirement savings should normally be a higher priority than long-term debt or other savings at least to the point of maximizing tax-deferred options.

"If one does not save adequately for retirement, one may completely outlive one's income," he says.

However, Duong says that if you have high-interest consumer debt, like credit card balances, you should address that before adding to your retirement savings.

As an example, he says someone who contributes to their retirement account earning 7 percent instead of paying down the balance on their 18 percent credit cards is hit with an 11 percent loss each year. That means you are actually losing money.

"You're going to have a very tough time growing your net worth if you lose 11 percent every year," says Duong.

Consumer and Credit Card Debt

In general, Duong recommends looking at three factors when prioritizing your debt repayment - the interest rate on the debt, whether your interest expense is tax deductible, and your current financial situation.

Since consumer debt, such as credit cards, typically carries a higher interest rate than a mortgage, it should take priority over paying down your home loan, says Duong.

According to him, credit cards typically carry a very high interest rate of 18 percent or more annually, which is much higher than the rate on a mortgage, auto loan, student loan, or most other debt.

"Typically, that means you should be focusing on high-interest consumer debt first, like credit cards, and paying down lower interest and possibly tax-deductible debt like student loans and mortgages later," Duong says.

That's right – the interest on your mortgage can be written off on your taxes, while the interest on your credit cards isn't tax-deductible, says Duong. So attacking credit card debt should be near the top of everyone's list of financial priorities, he explains.

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Education Funding

When it comes to paying for college, our experts say you may want to prioritize it ahead of your mortgage depending on the age of your children and the time left on your mortgage.

"Education needs usually occur before one is ready to pay off the mortgage," says Drury.

However, Duong says his advice is that parents should always prioritize saving for their own retirement over saving or paying for college.

"The reason is that you can't borrow money or get a scholarship to pay for your retirement," says Duong. "On the other hand, a child has a wide range of options, from grants, scholarships, and loans to work-study programs and part-time jobs, to fund their education."

But be aware that the interest rates on student loans vary based on the type of loan and whether it is federal or private, says Duong.

"Currently, the rates on Federal Direct Loans are lower than the typical 30-year fixed mortgage rate," he says. "However, Direct PLUS loans currently carry an interest rate of 6.41 percent, making them higher than most mortgages."

Mortgage

Once you've taken care of your other financial priorities, what's the best way to pay off your mortgage? Duong suggests paying down the principal early in the mortgage term and early in the mortgage year to reduce the interest you pay over time.

"If you can afford to do it, make extra payments as soon as you have the money to do so," he says.

Another possible tactic is to refinance to a mortgage with a shorter term, says Melissa Joy, CFP and director of investments at RJFS, a financial solutions firm in Southfield, MI.

While a shorter term means taking on higher monthly payments, she says that the lower interest rate and ultimate savings are worth it.

Based on today's rates, Joy compares a 30-year fixed-rate mortgage at 4.5 percent to a 15-year loan at 3.5 percent.

On a $200,000 mortgage, the 30-year monthly payment at 4.5 percent is $1,013. However on the 15-year loan the payment is $1,430. Joy acknowledges that the shorter term mortgage means about $5,000 more in payments each year, but the long-term savings make it a good choice if you can afford it.

"Over the life of each loan you would pay $364,813 on the 30-year loan, but on the 15-year loan you pay only $257,357," she says. "That's more than $100,000 in savings for the loan with the shorter term."

Joy likes this tactic so much that she applied it to her own mortgage.

"I went from a 30-year mortgage to a 15-year mortgage which meant that I was paying more toward principal immediately, and it will be paid off before my kids are in college," she says.