Dear Alpha Consumer,
I have a $10,000 bank certificate of deposit that matures in a month. I don't expect to need this money anytime soon, and CD rates have dropped so much that they're not attractive. Would it make more sense for me to use the money to pay down the principal on my 5.75 percent fixed-rate mortgage? My concern is that doing so would lower the mortgage-interest deduction on my income taxes. Any ideas?
Since there's never one right answer to this kind of question, I asked several financial experts to weigh in on what they would do. It turns out they all agreed that investing it—and not paying off mortgage debt—was the best approach. Here's what they had to say:
• Christopher Reilly, senior vice president and retirement planning specialist, Firstrust Financial Resources:
If you have other assets to lean on and you need your mortgage to end earlier, then the impact of early principal payments is appealing. However, if you do not "need" the money, consider investing it. The growth of the investment must outpace the net cost of the loan, say 5.75 percent minus a 25 percent bracket deduction, leaving a rough bogey of 4.3 percent. Even though investments can lose principal, you should think it through, get customized advice, and ultimately focus on combating principal erosion due to inflation and taxes measured after 10 years of patience. You could treat it like your personal healthcare fund or pay off your mortgage at that point.
• Keith Fenstad, Tanglewood Capital Management:
Once you factor in inflation and taxes on CD investments, they often lose purchasing power over time. With one-year CDs now paying in the low 3 percent range, searching for alternatives makes good sense. Generally speaking, paying down your mortgage would be a better use of those funds, assuming you are still retaining sufficient liquidity for emergency cash reserves.... Also, if your mortgage is fairly new, you'd get more "bang for the buck" by making a large principal payment now. When a loan is amortized, you pay most of the interest on the front end. As it matures, a larger percentage of your monthly payment then gets applied to principal. What this ultimately means is that over the life of the loan, an extra payment made in the early years of a mortgage will save you more interest than an extra payment made in the later years.
All that said, if it were me, and this was truly long-term money (seven-plus years), I would consider taking advantage of this latest market downturn and reinvest in a good balanced mutual fund.
• Ryan Haffrey, vice president, financial consultant, Charles Schwab Palm Beach branch:
The best solution for the $10,000 is going to depend on your overall financial situation, not necessarily the difference in today's CD rates versus your mortgage rate. In addition, it's quite likely that the $10,000 is not going to dramatically reduce your mortgage payment or the amount of interest deduction you may receive. Keeping that in mind, make sure you have an emergency fund in place and have paid off any bad debt before you allocate the money. If you're close to having your mortgage paid off, compare your mortgage rate to the interest rate on CDs that have a maturity equal to the expected life of your mortgage. Invest in the one with the higher rate.
If the life of your mortgage is greater than 10 years, you might be better off using the money in a diversified, growth-oriented portfolio that will likely earn a better return over a similar period of time. If you don't have a personal financial plan, now may be the perfect time to meet with a qualified professional.
• Mary McGrath, executive vice president, Cozad Asset Management:
I know it may be tempting to want to pay down your mortgage with excess funds, especially when an investment in CDs is going to bring in a lower return. But try to keep a long-term perspective. The mortgage, being fixed, is a long-term obligation that is costing only 5.75 percent. I'm not sure what the remaining term on the mortgage is, but even if you consider it to be a 15-year mortgage, one should be able to make more than 5.75 percent on this money over a 15-year period. Maybe not over the next 12 months, but certainly over the remaining term on the mortgage.