Monday, April 16, 2007

401K vs. Extra Mortgage Payment

If you find yourself with some excess income these days, you may be wondering whether you should put more money into your 401K or pay off your home mortgage faster.

Which is better?

From a purely financial perspective, if you have a low, fixed mortgage rate you are better off putting money into your 401K account. There are 2 reasons for this:

  1. Any extra money you put into your house will have already been taxed. That means that your money has already lost 20% of its value before you are able to use it to pay down your mortgage. 401K contributions are pre-tax, meaning the money goes into your 401k account before any taxes are removed from your paycheck.
  2. Your 401K will likely earn more than what you pay in interest on your house. Let's say your mortgage rate is 6%. Even at a conservative 8%, your 401k will out-earn what you pay in interest by 2%.
However, this doesn't necessarily mean its a bad idea to pay off your house early. You will most likely still save thousands of dollars in interest payments. Moreover, you will eliminate a high monthly debt responsibility. This is a nice scenario if you happen to find yourself without a job for an extended period.

Although both scenarios make financial sense, putting extra money into your 401k will probably give you the most bang for your buck.

3 comments:

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Marjorie J. said...

Thank you for sharing this information.This is such a great article fidelity 401k .

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