To prepay your mortgage or invest in your 401K, that is the question. A recent study released by some Professors working together at several top notch business schools have confirmed what those of us in the know have been preaching for years - prepaying your mortgage isn’t always the best financial decision. The study evaluates whether borrowers are better off prepaying their mortgage or using the money to invest in a tax deferred account like a 401k. The winner was the 401k.
The study showed that borrowers who invested in a conservative 401k returning just 5% annually would see and additional benefit of 11 to 17 cents per dollar greater than if they prepaid their mortgage. I think this article is timely, but also I believe it also shows how much misinformation is floating around about mortgages and making the right financial decisions. It wouldn’t surprise me to see more articles challenging conventional wisdom about mortgages such as interest-only versus P&I payments, down payment amounts, ARMs versus fixed, etc.
One of the chief caveats of 401(k) investment is that there is an upper limit on how much you may invest every year. This also applies to 403(b) investments, and almost every tax-deferred or "qualified" plan account. The IRS limit for 401(k) contributions for the 2006 tax year wwas $15,000.
An interesting alternative to pre-paying your mortgage in lump sums is a true bi-weekly mortgage, which may, depending on your lifestyle, income, and interest rate, be able to build more equity, more quickly than classic lump sum annual mortgage pre-payments.
One may also want to consider how much longer they will be in the workforce contributing to a 401k or 403b. Like most investments, it is important to diversify your capital outlays.
Whether your are prepaying your mortgage, investing in your 401K or using any other investment vehicle, be sure to consider the tax ramifications. The best way to do this is to work with a professionaly financial advisor who understands how each decision you make - as well of the sum of all your financial decisions - will affect when how much you pay in taxes.
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